P2P and private debt: P2P’s USP

Peer-to-peer lending occupies a unique space in the private debt sector. Kathryn Gaw explains…

The private debt sector has risen to a new level of prominence over the past year. Rising interest rates and the higher cost of living has piled pressure onto borrowers across the world, forcing lenders to make difficult decisions about who they back and where they secure their funding. For the biggest lenders – high street banks and other legacy institutions – this has led to an overall reduction in lending activity.

According to the Federation of Small Businesses (FSB), by the start of 2022, there were 5.5 million small- and medium-sized enterprises (SMEs) in the UK, making up 99.9 per cent of the business population of the country. The FSB found that these SMEs account for three-fifths of the employment and around half of turnover in the UK private sector. The success of these businesses is therefore paramount to the health of the overall economy, yet few mainstream lenders are stepping up to offer support when it is arguably needed the most.

This has created an SME funding crisis in the UK. The Centre for Economics and Business Research (CEBR) has predicted that approximately 7,000 SMEs will go bust during every quarter of 2024, as pandemic-related debt, higher borrowing costs and the cost-of-living crisis take a toll. Meanwhile, the British Chambers of Commerce (BCC) has joined other business representatives to call on the Treasury to improve access to finance for SMEs amid some of the most difficult economic conditions seen in generations.

“The system desperately needs to change,” said the BCC in a recent statement. “With investment in the UK economy continuing to toil in the doldrums, we must widen the pool of financial options available to firms to kick-start the growth we need.”

This is where the private debt markets come in. Preqin has estimated that the private credit space has grown to almost $1.2trn (£970m) globally, and it is set to double in size by 2026. This space is dominated by large institutions such as mezzanine lenders, distressed debt funds and private equity firms. The largest names in the UK include Ares Management, Pemberton Asset Management, Permira and Ardian, who collectively manage private debt portfolios worth hundreds of billions of pounds.

By contrast, the total value of the UK’s peer-to-peer lending sector is less than £2bn – a relative drop in the ocean of private debt financing.

Yet despite its small size, P2P lending occupies a crucial space in the private debt market that cannot be understated.

“P2P lending helps facilitate growth for young businesses,” says Roy Warren, managing director of Folk2Folk. “No one else can be bothered to deal with them.

“Traditional high street banks and private debt funds are moving up the food chain and selecting their top 20 clients, so there is less space for the smaller enterprises to secure funding. P2P fills a very valuable gap in the market.”

The majority of the larger firms focus solely on high-value deals, worth £1m or more. By contrast, P2P property lender Kuflink is currently listing a series of loans valued at between £8,384.49 and £354,000. The flexibility to offer funding for smaller SMEs is what truly sets P2P lenders apart from the rest of the private debt world.

“We provide borrowers with an alternative method for borrowing and a number of avenues for credit as we’re not only funded by institutions but by high-net-worth individuals and sophisticated investors,” explains Narinder Khattoare, chief executive of Kuflink.

“No matter what the financial climate looks like, you can see evidence of that during Covid when most lenders stopped lending and the P2P platforms were still trading.”

The investor experience is another way in which P2P distinguishes itself within the private debt space. The majority of private debt lenders are funded either by institutions or by private equity funds. And while P2P loans are becoming more popular with institutional investors, they are primarily set up to serve retail investors. By definition, P2P lending involves individuals lending to other individuals (including business owners). This means that the average investor can support SMEs and their role in the economy, while also earning inflation-beating returns that are usually much higher and more consistent than bank or stock market earnings.

Read more: Investors look to increase allocations to private debt

“P2P is about democratising investment,” adds Folk2Folk’s Warren.

“Even though we have a relatively high investor threshold of £20,000, it’s not £2m or above like some private debt specialists. It’s still accessible for an individual sophisticated investor.”

Neil Faulkner, managing director of P2P ratings agency 4th Way, agrees that P2P lending expands access to bank-like money lending, adding that it “has become one of the most transparent types of investment available, which is essential for assessing the risk-reward balance.”

“P2P lending also adds a new source of funding for borrowers,” says Faulkner.

“This helps to fill a funding gap and creates more stability in the wider credit market. It is also a seeding ground for budding lending businesses, as well as a new route to fund loans for established alternative lenders that see advantages in expanding into P2P.”

Clearly, P2P lending occupies a niche but vital space in the private debt market, but as banks withhold their lending, is there room for that space to grow?

Recent research from Ares Management noted that analysts have observed tightening credit across most non-bank lenders for the past year, with signs pointing towards credit performance deterioration in the future. As a result, Ares said that non-bank lenders are recalibrating their underwriting models, with originations by US-based private debt funds slowing by an average of 33 per cent since 2020.

This could represent an opportunity for P2P lenders.

“I do think there is an opportunity for P2P to grow its share of the alternative credit space,” says Khattoare.

“There is also an opportunity for some of the bigger players in this space to collaborate more and make it bigger than what it is – previously you had the big three or four who no longer exist in this space but the current crop are doing great things and I totally believe it’s here to stay for the long term as we do all plug a gap in the market.

“If we were solely reliant on the high street banks then the SME space would be dead. SMEs make up the majority of the UK economy so you need alternative lenders to operate in the market providing innovative solutions for borrowing – there are some great alternative lenders doing good things aways from the high street.”

P2P lending may represent just 0.1 per cent of the private debt space, but that 0.1 per cent is working hard to support 99.9 per cent of UK businesses during a period of unprecedented rate rises and economic instability. It is a small but vital share of an increasingly relevant sector of the financial services market which deserves its due.

As the newly-rebranded Alternative Credit Investor, we will continue to cover and support the P2P sector as we monitor its role within the wider private debt space in the years to come. Our hope is that P2P will continue to grow and thrive without sacrificing the tenants that make it so special.

There are many private debt firms out there willing to invest in debt packages, or to lend to established players with books full of multi-billion-pound projects. But there is a clear need for the sort of lenders who can pick up the slack during an SME funding crisis and provide financing to smaller firms which deserve a chance to grow, no matter what the economy is telling them. P2P is a particularly special corner of the private debt market, and whatever the future brings, its impact will not be overlooked.