Macroeconomic Outlook: Navigating choppy waters
Challenging macroeconomic conditions should not impede the growth of peer-to-peer lending, as Kathryn Gaw reports…
Nobody is immune to the impact of macroeconomic volatility, including peer-to-peer lenders. Slow economic growth leads to higher base rates, which increases the cost of mortgages and other loans. Meanwhile, the rising cost of goods and services can eat in to any disposable or investible income, meaning that there is less money being used to fund vital projects such as housing developments and business expansions.
P2P lending platforms have been quick to respond to these changes. Over the past few months, many platforms have increased their investor rates, citing a more competitive investment environment and the rising cost of borrowing. These higher investor returns have typically been covered by charging higher borrower rates.
Many platforms have also enhanced their due diligence processes to further reduce the risk of borrower defaults, or have taken on more institutional funding to supplement their retail investor base.
“Over the last six months we have seen slightly more re-terming requests and extension requests than we would ordinarily like,” says Paul Auger, chief operating officer at Kuflink. “You have to take a view on some of these that yes, we will extend the loan but on others we just want the money back.
“We need to be fair and equitable to our investors because it’s their money. We need to make sure that we keep an eye on what’s going on in the macroeconomic climate and we need to look at things on a regional basis.”
However, for the most part it has been business as usual for P2P lenders. After all, this is a sector which was borne out of the global financial crisis, and has already survived several recessions and a two-year pandemic. P2P lending thrives in chaos.
Read more: Invest & Fund: Higher base rate alone will not boost lending pricing
Furthermore, several platforms are spotting new opportunities in the current economic climate. Latvia’s Lande Finance says that it is “battling to resolve the current market problems raised by investors” by financing agriculture projects across Europe. Meanwhile, property lenders such as CrowdProperty and Kuflink have helped to bolster the housing market by funding hundreds of property developments across the UK.
As banks pull back their funding and raise their borrower rates, more and more businesses and consumers are venturing beyond the mainstream in search of financing. This too has created an opportunity for P2P platforms.
Unlike banks, P2P lenders are not directly influenced by the Bank of England and its recent rate hikes, but central bank movements will always influence platform economics. For instance, Kuflink’s senior management meets after every Bank of England interest rate decision, to discuss any possible impact on the platform’s lenders and borrowers.
“It’s a fine balancing act because a few investors have asked us previously, why don’t your rates go up every time the base rate goes up?” comments Auger. “We have to balance that because there’s a margin that we have to achieve. It’s not as simple as putting the rate up, because if you put the rate up for the investors, you also have to put rates up for borrowers.”
Read more: ‘In turbulent times, P2P has role to play in a balanced portfolio’
This balance can be tricky to manage as higher borrower rates can potentially lead to a higher risk of default. The challenge for lenders is to maintain competitive investor rates without risking the underlying capital investment.
Many platforms have opted to offset this risk by taking a form of security on their loans. Usually, this security will be a property, which can theoretically be sold off in the case of a borrower default, in order to recoup investors’ capital. But of course, the macro environment can also wreak havoc on the value of these securities.
Banks have been quick to pass on the higher base rate to their mortgage customers, making the cost of borrowing much higher. Higher mortgage rates have led to a reduction in the number of mortgage approvals, which has contributed to a slump in housing prices. According to data provider LonRes, central London property prices dropped by almost five per cent in the 12 months to March 2023 –the largest annual fall in three-and-a-half years.
Luckily, most P2P platforms will limit borrowers to between 60 and 70 per cent of the value of the property that they are using as security. Known as ‘loan to value’ or LTV, this means that the property would have to fall in value by between 30 and 40 per cent before investor capital was at risk. A five per cent decrease in property prices is bad news for property owners and brokers, but it would have little to no impact on the value of the security behind P2P loans.
Read more: BoE rate hike: P2P chiefs urge diversification
“Higher interest rates for many after increased debt accumulated during the crises of the past three years has already been taking its toll,” explains economist and business consultant Vicky Pryce.
“What’s more, the recent difficulties faced by a number of smaller banks but also by Credit Suisse have highlighted the dangers brought about by the fast and sharp rise in interest rates over the past year.
“More liquidity support from central banks has been made available but the expectation is that lending conditions from banks may tighten ahead. If that proves to be the case then P2P lending should have a bigger role to play even if interest rates start to fall at some point, as is widely expected.”
However, rates aren’t expected to fall any time soon. Over the past several months, inflation has been hovering around the 10 per cent mark, with little respite on the horizon. This has led to speculation that the Bank of England will increase the base rate by a quarter of a percentage to 4.5 per cent in May, with many analysts expecting the base rate to reach five per cent by the autumn.
Bruce Davis, managing director of Abundance Investments believes that prolonged high levels of inflation will change the investment landscape for everyone.
“Inflationary pressures and the increasing cost of money are changing the investment landscape,” says Davis. “Particularly for long term infrastructure projects where cost of capital is an important factor.”
Read more: How will the property downturn impact P2P lending?
Peer2Peer Finance News understands that the regulator is already meeting with platform representatives to navigate this new economic landscape, in a nod to the growing influence of P2P lending on the UK economy. This represents an opportunity for stakeholders to address key concerns, such as the lack of innovation in the UK fintech market.
“The key concern for the crowdfunding and P2P lending sector will be the continued pace of regulatory change which is causing significant uncertainty for UK finance businesses and risks,” says a spokesperson for the UK Crowdfunding Association.
“This makes the UK uncompetitive for developing new innovative finance propositions relative to the EU and US markets.”
Since P2P lending was founded in 2005, it has helped to fund billions of pounds worth of construction projects, property refurbishments, business launches, business expansions and agricultural projects. Clearly alternative lenders can add value during times of economic volatility, by offering a safe harbour for beleaguered borrowers – just as long as they can pass the platforms’ strict credit checks.
And when the economy does pick up, there will be opportunities there as well.
“The economic conditions in 2023 have been better than expected six months ago, with inflation and energy bills starting to fall, which means P2P lenders should see better credit conditions for both lending and collections,” says Mike Carter, policy lead for lending platforms at Innovate Finance.
“The hope is that this trend continues for the rest of the year, providing a good backdrop for both lending and investor returns.
“Beyond 2023 there are some macro policy changes which could benefit P2P lending significantly,” Carter adds. “The combination of the steady reversal of quantitative easing and potential changes to the bank deposit insurance and related bank liquidity rules is likely to reduce bank liquidity available for lending, and P2P lenders will be needed to help fill this increasing gap for small- and medium-sized enterprise and consumer borrowers, as they have done over the last 10 years.”
As the aphorism goes, a rising tide lifts all boats, and P2P will benefit alongside other members of the UK economy when macro conditions improve. But in the meantime, the sector has yet another opportunity to demonstrate its ability to survive volatility while continuing to deliver steady returns to investors.
