Peer-to-peer lending: We do your homework

For investors searching for yield, peer-to-peer lenders are worth checking out. Returns in the ballpark of 10 per cent pa are on offer – some are even higher for those prepared to take on more risk. A string of operations have set up in Australia, eyeing the fat profits made by our big four banks and hoping to use technology to take a slice of the action.

Peer-to-peer online platforms match investors with borrowers seeking personal or business loans, then clip the ticket. The outfits keep overheads low to offer a better deal to both sides. And the operators are cherry-picking the best risks, particularly while they are new and trying to establish credibility with lenders.

Since we last covered the sector (Peer-to-peer lending: Is it for you?, December 17, 2014), prospective lenders have more choice.  Some operations are open to retail investors, while some are only accessible to sophisticated investors, but the sector as a whole welcomes SMSFs.

Each one has quite a different model and different rules. For example, RateSetter has a minimum investment of only $10 – the logic is that investors can lend a small amount to see how the platform works and gain confidence that their money will be returned with interest on time. By contrast, DirectMoney has a $50,000 minimum investment, the idea being that large contributions are more efficient for the operator to process. Durations also differ – RateSetter allows a minimum term of one month for lenders (although borrowers face a minimum term of six months), SocietyOne offers a minimum term of 18 months for livestock loans, and DirectMoney has a minimum term of three years – even if lenders begin their investment with an open-ended timeframe, once they decide to withdraw funds, the exit time is three years.

Here's a guide.

RateSetter

RateSetter originated in the UK, launched in Australia in November last year and is open to retail investors. In Australia, the lender has funded $6.64 million of loans across 410 loans, with an average loan size of $16,196 and an average term of 39 months.

The top reason given for taking out a loan so far is to buy a car, and the second most common reason is home improvement. The minimum investment is $10, allowing lenders to try out the platform before committing a more substantial sum.

For investors searching for yield, the rates on offer look appealing. Rates are matched by the marketplace: An investor can see the most recent matched rate for periods of one month, one year, three years and five years. They can then decide what rate to ask for: perhaps a slightly higher rate, if they are prepared to wait for a borrower who will accept it, or a slightly lower rate, if they wish to match their funds quickly. The most recent matched rates are displayed on RateSetter's website – at the time of writing it was 9.4 per cent for five years, 7.8 per cent for three years, 5.1 per cent for one year and 4 per cent annualised for one month. Of course, these rates are before tax, and no franking credits apply.

As the returns are determined by borrowers and lenders agreeing with each other, the varying levels of returns don't indicate whether a loan is higher or lower risk. At this stage, RateSetter is only matching a fraction of the demand for loans, in order to cherry-pick the best applicants. Borrower demand in the past 30 days alone has been $17.63m, almost triple the total amount of loans matched in the past nine months.

CEO Daniel Foggo expects that more SMSFs will lend on the platform over time. There are currently 1162 lenders on the platform, around 10 per cent of which are SMSFs. Only 5 per cent of lenders are aged over 65. “In the UK it's more like 20 per cent over 65,” he says. “We are actually attracting a younger demographic but I think as the industry matures it will attract a more mature audience.” He says four or five lenders have $200,000 or more on the platform, some of which is through SMSFs.

RateSetter publishes statistics about its lenders and borrowers on its website. For example, the current average amount invested is $6379. The organisation also publishes its rate history, which shows that rates have fallen a little since launch. Foggo expects that as investors get more comfortable with RateSetter's track record, rates will continue to come down slightly. He points to the experience in the UK, where there is a longer track record and rates are lower than in Australia.

Lenders are right to question how much capital risk they are taking. RateSetter has established a Provision Fund, funded by a fee paid by borrowers, which aims to compensate lenders if a borrower gets behind in their payments or defaults. “Personal loans are a very well understood risk category,” Foggo points out. RateSetter conservatively expects defaults of about 2.8 per cent of the $6.03m it has on loan and currently has $442,697 in its Provision Fund, which it says is more than two and a half times enough to cover its expected defaults. Foggo points out that all lenders in the UK and Australia have received their principal and interest back so far, and that the company over the longer term expects to provision between two and three times its expected defaults. In Australia so far, two loans are in arrears and the lenders received their payments on time thanks to the Provision Fund, while no loans are in default, Foggo says.

In a recession, if defaults tripled from their expected level, lenders should still expect to get their money back, he says. In a situation of stress where the Provision Fund didn't cover all expected defaults, Foggo says the company would start managing its payouts to pay out the capital as a priority, ahead of the interest. But he is confident enough is set aside to handle an increase in defaults.

Watch Alan Kohler's video interview with RateSetter CEO Daniel Foggo here.

SocietyOne

SocietyOne is only open to sophisticated investors at this stage, but is working on plans to open to retail investors too. The platform has funded approximately $40m in loans since opening in Australia in 2012, choosing from among the $190m in loan applications received. SocietyOne offers investors the opportunity to lend to unsecured personal loans and secured livestock loans, and CEO Matt Symons says the group is working on a number of other asset classes.

Investors are able to choose different credit grades, such as opting only for the best risks, or spreading their investment across a spectrum of risk levels. The rate of return depends on the level of risk chosen. The minimum investment for personal loans is three years and for livestock loans it's 18 months, although investors can also choose different term structures.

Investors can also make specific decisions, such as only funding loans to homeowners, or to people in a certain geographical area, or to borrowers with an income to expense ratio above a certain level. Investors can also see on the SocietyOne platform the interests they have at any time. “We're diversifying the investor across classes,” Symons says. “It's helpful in terms of mitigating risk.”

Symons says that a lender who had invested in all loans written on SocietyOne's platform since launch, across livestock and personal loans, would have generated an annualised return of approximately 10 per cent after fees and defaults. He emphasises that historical returns aren't a predictor of future returns.

Equity shareholders backing SocietyOne include Kerry Stokes' private company Australian Capital Equity, James Packer's Consolidated Press Holdings, Rupert Murdoch-chaired News Corporation (publisher of Eureka Report) and Westpac's Reinventure venture capital fund.

Alan Kohler will interview SocietyOne CEO Matt Symons on Thursday, August 6 at 12.15pm.

DirectMoney

DirectMoney launched in October last year and so far has loaned out about $6.5m. It opened to retail investors in May, who have moved $625,000 onto the platform so far.

Founder David Doust explains that under the DirectMoney model, investors don't bid on an approved loan, unlike other peer-to-peer lenders. Instead, DirectMoney funds loans as soon as they are approved, using its own capital, then holds some loan inventory in a warehouse that is available for retail lenders as demand comes in. “It's a better experience for the borrower if we have funds settled – it means borrowers can receive funds straight away,” Doust explains.

When retail investors join DirectMoney, they can invest in one fund, rather than picking individual loans. In order to keep expenses down at this early stage, the fund is only open to new investments on the 15th of each month and at the end of each month, and Doust advises investors to put their money on the platform just before these days, rather than just after.  

The loan fund mixes loans of different risk and return levels in what Doust calls a “compulsory diversification” approach. “We don't believe consumers have the skills to be picking their own portfolio because they may be tempted to go for higher returns,” he says. “To get a stable annual return and a stable loss rate it's better to have credit experts picking the stable of loans.” DirectMoney vets borrowers with procedures it says are stricter than the banks, insisting on borrowers having at least three years of employment, with no major defaults and an ability to repay the loan easily.

The minimum investment is currently $50,000 as the team gauges interest and aims to reduce costs. “If the market demands smaller amounts we'll respond to that,” Doust says. Fees including GST are 3 per cent pa.

DirectMoney expects an annual return of approximately 7.5 per cent for the retail fund and defaults of about 4 per cent. Although there haven't been any losses in the fund to date, the group has been putting aside around 4 per cent of the money on its platform to cover any future losses. Distributions from the retail fund were 7.48 per cent annualised for June and 7.41 per cent annualised for part of May. Doust expects “fairly stable” returns around this level, which he says is a good target return given the diversity of the loan exposures.

The minimum investment is three years. Investors can choose to put money on the platform and receive interest and principal back in 36 monthly payments, or to leave principal on the platform and receive interest only for a time. When investors decide to withdraw their principal, it takes three years for the sum to be repaid. Doust says this model helps avoid a situation of stress where everyone tries to withdraw their money at the same time.

DirectMoney executive chair Stephen Porges will be in the studio for a Eureka Interactive interview in October.

ThinCats

ThinCats enables sophisticated investors to lend to small businesses, largely for growth finance. The Australian business is a joint venture with the more established UK operation. In Australia, CEO Sunil Aranha says ThinCats has written about 10 loans so far, all at rates between 11.5 per cent and 14 per cent in the hands of the lender. This is after ThinCats takes a fee from the borrower of 4.5 per cent, capitalised into the loan. The platform is also looking to introduce a lender fee, perhaps around 0.5 per cent of the loan principal.

Investors can bid in an auction for available loans in minimum fractions of $1000. So one investor might bid for $3000 of a loan at 13.5 per cent, while another might bid for $50,000 of the same loan at 13 per cent, for example. If a loan is oversubscribed, the bidder with the highest rate gets knocked out, so that the borrower will get the best deal.

Small businesses can apply for loans for periods of two, three or five years. In the UK, ThinCats operates a secondary market that allows investors to sell their loan to a third party and get their money back sooner. Aranha suggests this is possible in Australia in the future, but for now, investors are tied to the term they choose.

Aranha points out that small businesses looking for funding will often start with a home loan, then an overdraft. For businesses looking for another form of finance, ThinCats can step in with a loan above the overdraft rate. ThinCats takes the first charge over the business and always takes a director's guarantee as a form of support.

Borrowers explain their business plan for repaying the loan, while ThinCats runs a credit check for the individual and business seeking funds, and verifies their identity. In some cases ThinCats will visit the facilities of the borrower. This information is then placed on the ThinCats website, where lenders can consider the risk and also ask questions before bidding on the loan.

Watch Alan Kohler's video interview with ThinCats CEO Sunil Aranha here.

Marketlend

Marketlend also provides loans to businesses, offering a working capital facility or line of credit to borrowers. After launching to sophisticated investors in December last year, Marketlend has $14m on platform and $2.5m in the pipeline.

CEO Leo Tyndall says the group does fairly significant due diligence before listing a loan on its website. The team talks to every borrower and requires financial information. Marketlend's credit team review the borrower's application and accountants analyse the borrower's financials. The borrower is subject to credit rating checks and court registry searches. Marketlend then gives the borrower a risk rating, which sets the range of interest rates that apply to that loan.

The loan is listed on the Marketlend website for two weeks and investors can look at the financial information and make bids within the range at the interest rate they think is suitable. If loans are oversubscribed, they are covered at the lowest interest rates that lenders offered. Tyndall compares the process to a bookbuild on a smaller scale.

The minimum loan size is $5000 and there is no upper limit. Borrowers pay total fees of 3.65 per cent, although these are cheaper for larger loans above $1m. For example, for a borrower in the C-grade category of an 18-22 per cent interest rate, if a borrower pays 18 per cent interest, Marketlend takes a 3.65 per cent fee and returns 14.35 per cent to the investor. Tyndall contrasts this with a corporate credit card available from a big bank with an interest rate of 20 per cent or higher.

As of July, Marketlend has an average net yield of 14.61 per cent pa, and says investors can expect to receive yields between 10 and 15 per cent. Marketlend has had zero defaults after seven months and invests in every loan it offers to lenders. “If we won't invest, we won't put it on our platform,” Tyndall says.

Watch Alan Kohler's video interview with Marketlend CEO Leo Tyndall here.