An Article by Peer2Peer Finance News
Institutional investment is changing the P2P lending landscape. Michael Lloyd investigates the growing role of institutional money in P2P, and how to catch that big fish…
Institutional investors are the big fish of the peer-to-peer investor community. While retail lenders can back their chosen P2P platform with as little as £10, institutional investors such as family offices, venture capital firms, investment groups, asset managers or banks can afford to invest millions, even tens of millions to back new lending and aid platform growth.
As the P2P sector matures, more and more institutional investors have begun to express an interest in backing P2P loans through partnerships with P2P platforms.
A raft of institutions have already invested in the sector, including Aros Kapital, Fasanara Capital and Varengold Bank, as well as a number of anonymous private investors.
Amid an ongoing regulatory crackdown on retail investing criteria, institutional investors have become a more attractive prospect for P2P platforms. Platforms may seek funds to aid their expansion plans, and typically agree funding lines with institutional partners to commit to finance loans on the platform, which then allows the platform to plan its growth.
Generally speaking, the balance of money in the P2P space is steadily shifting away from retail and towards institutions as platforms mature and regulation tightens. The new ‘big three’ of the largest platforms, Assetz Capital, which has lent £1.4bn to date, Folk2Folk, which has deployed over £500m, and CrowdProperty, which has cumulative lending of more than £250m, have all taken institutional funds.
Institutional funds also provide certainty of funding. While retail money is generally stickier, it is difficult to attract and maintain, particularly when there are so many marketing restrictions around any product aimed at a consumer audience.
Some platforms have even left the retail space entirely in favour of institutional funding, such as Funding Circle, Landbay, LendInvest and ThinCats.
All things considered, it is easy to see why so many platforms have been courting institutional money in recent years. But in order to catch these big fish, platforms must know what institutions look for.
In conversations with Peer2Peer Finance News, both P2P lending platforms and institutional investors described an extensive due diligence process in which institutions look for predictability of returns, an excellent track record, scalability, a good risk-reward balance, and the ability to deploy lots of capital.
They also examine the origination process, credit performance, risk management and quality of the management team as well as checking that all the required compliance procedures are adhered to.
Folk2Folk, which is in discussions with several institutional partners including insurance companies, challenger banks, asset managers and local authorities, describes this process as a “comprehensive analysis of the platform”.
“Their particular focus is on processes and procedures and ensuring all the checks and balances are in place,” a spokesperson from the platform says.
Alison Harwood, head of the London branch of Varengold Bank, which has invested in alternative lenders such as EstateGuru, Assetz Capital, MarketFinance and LendInvest, says the bank’s criteria for investment is no different when it comes to P2P lending platforms.
She says the bank does not favour one loan type over another and before onboarding with a platform, Varengold will send a lengthy due diligence questionnaire. It will also scrutinise a host of supporting materials including the loanbook, and will conduct a series of interviews with the senior management team.
“Track record is the core part of due diligence, and the loanbook is core to getting the feel of loans the platform is originating,” she says.
“I wouldn’t say we particularly favour one thing over another. We like increasing access to financing, we like low-risk lending, things like property-backed lending, depending on how it’s done. If it’s low loan-to-value bridge lending it’s good from the risk perspective. If it’s prime consumer unsecured lending, your risk is very low. It depends on the book.”
Harwood adds that the due diligence process needs to be extended to cater for the P2P element which presents a “little more operational risk” for an institutional investor.
“An example could be if they don’t manage the retail side of the platform properly, the Financial Conduct Authority could take away their P2P licence for something entirely unrelated to the institutional side of things,” she says.
“It’s a very nuclear thing to have the licence taken away, it would likely mean the platform collapses or is indicative they are not doing something right elsewhere. There is quite a lot to deal with making sure they are handling the P2P side of things right.”
Will Senbanjo, partner at ACP Altenburg Advisory, a firm which advises platforms looking to raise debt finance from institutions, says that institutions look for growing platforms that present efficient ways of investing a portion of their large pool of capital.
He says institutions search for platforms that have a strong track record, and they always ensures that there is no conflict between them and retail investors, by either investing alongside them or by making their investment via a special purpose vehicle.
“Institutions look for a platform that’s growing, has their own niche in terms of the type of transactions they’re doing, has found an efficient way of deploying capital and has contacts in their space,” Senbanjo says.
While smaller platforms can attract smaller funding lines and Harwood says Varengold has even funded some lenders pre-launch, industry stakeholders believe that it gets easier for platforms to receive institutional funding after their total historical lending has reached the low tens of millions.
However, to seek a securitisation – which can aid future growth through cheaper funding – platforms do need to be a lot larger.
It is notable that the only UK platforms large enough to have completed securitisations are former P2P giants Zopa, LendInvest and Funding Circle.
“The larger you get, the cheaper the cost of funding is,” says Senbanjo.
“I see it as a funding journey from using family and friends money, high-net-worth money, venture capital or debt, which could be high costs and over a period of time, to getting funding at a lower cost. But the challenge is always between showing you’re large enough and have strong enough growth prospects to attract the lower cost of capital, and being able to deploy it.”
In order to further hedge against the perceived risk of a P2P investment, institutions may add extra terms and conditions, such as the ability to choose from particular tranches of loans, or having the platform take the first loss.
“If it meets the criteria, it will automatically be funded by the institutional investor,” says Senbanjo. “Some funders will fund a higher proportion than others. Most of these institutions want to fund on a senior basis.”
Varengold’s Harwood says platforms should ensure they have their ducks in a row before speaking to new institutional investors. This includes having up-to-date processes and documents, including their financial forecasts, management accounts, loanbook and performance statistics, that can be quickly and easily presented.
“Do some prep beforehand and go out and speak to as many investors as possible, maybe engage an adviser if you don’t have someone with in-house experience,” she says.
Stakeholders and institutions see P2P lending platforms as attractive and believe investment in the sector will continue to rise.
On the other end of the spectrum, some platforms have grown to considerable scale without much or any institutional lending. These include Kuflink, Relendex, Crowdstacker, LandlordInvest, Invest & Fund, HNW Lending and Loanpad, which all maintain they do not have any institutional investors and have instead relied upon retail and high-net-worth investors.
Several platforms go so far as to oppose institutional funds completely.
JustUs chief executive Lee Birkett says platforms that leave retail for institutional money only “lose their value in our opinion”.
“Institutional is short-term money while the crowd is sticky long-term money,” he adds.
Institutional investment will continue to find a home in P2P lending platforms, but it is by no means necessary for a platform’s growth.
P2P platforms must keep growing and showcasing their impressive origination model and loanbook track record in order to attract funds. If they continue scaling and showing their strengths, more money is likely to start moving towards the sector.
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