The Rise of P2P Lending
With interest earned on capital at a low, a decreased appetite by High Street lenders to lend to small and medium-sized enterprises (SME’s) in the wake of the financial crisis and an opportunity to use technology to gain an advantage over the traditional processes and systems offered by established lenders, the dramatic rise of peer to peer and peer to business (P2P) platforms has not been surprising.
For retail investors, P2P platforms purport to offer relatively handsome returns and transparency during the life cycle of a loan and have provided an alternative way to put money to work.
A P2P platform offers retail investors the opportunity to lend directly to small businesses, individuals and property developers with a higher rate of return than more traditional investment options even after the platform has taken arrangement and monitoring fees. For example, at present, P2P platforms offer expected net annual returns between 2.9% (RateSetter as of 7 December 2019) and up to 15% (Blend as of 7 December 2019). P2P platforms differ from investment based crowdfunding platforms, which typically see investors acquire a stake in a business by way of shares.
However, unlike with banks, building societies and many investment firms, investors’ money is not protected by the Financial Services Compensation Scheme, which covers deposits of up to £85,000 if a firm falls into insolvency.
The recent demise of P2P property platform Lendy has raised some concerns about the functioning of the P2P model in that particular case and whether the expected reward was worth the risk.
Indeed, following the collapse of the Lendy and Collateral platforms, it is understood that the Financial Conduct Authority (FCA) wrote to platforms in the industry warning them to clean up on poor practices or face crackdown, in a bid to increase oversight of the sector. The FCA is concerned that investors are taking on much greater risk than they realise, having been enticed by the prospect of higher returns in a time of low interest rates on capital.
It is understood that the FCA has commenced investigations and believes that some platforms are making changes to their business models without notification, driven largely by pressure to be profitable, which will ultimately have severe consequences on the stability of such platforms. The concerns are particularly related to property lending, including the extent of due diligence carried out on borrowers and the monitoring of the progress of developments.
The FCA’s review will also purportedly extend to a review of the adequacy of some firms’ financial resources, in light of concerns about the viability of platforms if investors withdraw.
For a market that has grown exponentially during relatively prosperous times, it may be that with the recent contraction in the economy (0.2% Q2, 2019) and the increased regulatory focus from the FCA, the P2P sector faces its first test in more challenging conditions. It may be, following the failure of Lendy and given that there are over 50 P2P platforms, that the sector may now encounter a period of sustained consolidation.
On 24 May 2019, Damian Webb, Philip Sykes and Mark Wilson of RSM Restructuring Advisory LLP were appointed as joint administrators of three Lendy companies – Lendy Ltd, Saving Stream Security Holding Limited and Lendy Provision Reserve Limited – following applications by the sole director of the companies.
The applications are understood to have been made in the wake of increasing pressure and scrutiny from the FCA, who had notified Lendy of its intention to wind the company up by order of the court.
The joint administrators’ proposals set out an interesting set of circumstances preceding Lendy’s demise.
Initially established in 2012 as a specialist lender in the marine sector, Lendy, in 2014, issued its first secured bridging loan and moved to being a property lending platform. In 2016 Lendy changed direction again and branched out into development lending – a more complex and riskier venture than property bridging finance
Lendy’s Lending Structure
Whilst initially structuring loans where Lendy purportedly acted as principal in relation to loans it made to borrowers, from late 2015 onwards Lendy’s future loans were structured as peer to peer, with Lendy acting as an intermediary through which investors could directly lend monies to borrowers.
Saving Stream Security Holding Limited acted as security trustee in respect of the security granted by the borrowers to secure these loans. Lendy Provision Reserve Limited (Lendy Provision Reserve) was the vehicle that held a discretionary fund in case of borrower default and was to hold a target amount equivalent to 2% of Lendy’s current loan book.
Lendy’s Peak and Demise
In June 2017, Lendy’s loan book peaked at £228 million, but by Q4 of 2017, as the level of non-performing loans steadily increased, confidence in the brand began to decrease along with levels of investment in the platform.
This decrease in investment led to Lendy reportedly being unable to fully finance many of its development loans, which in turn led to disputes with borrowers, a higher level of non-performing loans and a continued decline in new investment. Intrinsically linked to this decline in new investment was Lendy’s ability to generate income; it is understood that its greatest source of income came from the arrangement fees it obtained from new loans.
With the generation of new loans declining and faced with increased costs in connection with the non-performing element of its loan book, as well as increased regulatory scrutiny and supervision, the viability of Lendy’s business looks to have deteriorated.
Lendy’s Loan Book
According to the administrators’ proposals, at the date of appointment:
- The loan book had a value of £152 million, which was split between bridging loans of £36 million and development loans of £116 million;
- The loan book consisted of 54 live loans (29 of which were property bridging loans as well as 25 development loans);
- Of the 54 live loans, 35 have either had administrators appointed over the borrower company or receivers appointed over the borrower’s property;
- Whilst the estimated recoveries vary loan by loan, the administrators currently anticipate:
- An overall average return to investors of c57p in the £ before costs in relation to the development loans; and
- An overall average return to investors of c58p in the £ before costs in relation to the property bridging loans.
At the date of appointment, cash in the two bank accounts held by Lendy Provision Reserve amounted to £1.55 million. However, c£1 million of these funds were set off by the company’s fixed charge creditor, Metro Bank, in connection with a working capital facility that had been provided to Lendy. This leaves c£550,000 left in the reserve fund for the administration estate – a far cry from the target amount equivalent to 2% of the loan book of £152 million at the date of appointment.
The task ahead for the administrators will likely not be straightforward as they face the responsibility of adjudicating on the investors’ claims in the estate, dealing with the non-performing part of the loan book, and implementing an orderly wind down of the remaining book with a view to exiting administration by way of Creditors’ Voluntary Liquidation.
Investor and Creditor?
Notably, the administrators’ proposals explain how certain of Lendy’s investors have claimed they are also creditors of the insolvent estate. This is understood to be a claim formed on the basis that Lendy breached its contractual obligations and duties to investors as agent in connection with the operation of the P2P platform. The treatment of such claims will be important in the wake of recent news that investors may see decreased levels of recoveries due to costs that Lendy may be entitled to retain.
What Next for Lendy’s Investors and Borrowers?
P2P investors will be paying close attention to the Lendy administration as it unfolds. Of particular interest will be the outcome of the investors’ claims in the estate for its purported breach of obligations and duties as agent in connection with the P2P platform. This will be especially relevant if the underlying secured assets held by Saving Stream Security Holding Limited are insufficient to satisfy the secured liabilities and investors face a shortfall. Being able to claim as a creditor of the estate may present an additional method of recovery for investors, although this will depend on the platform’s asset base and the recoverability of such assets, and will be on an unsecured basis. The reserve fund also looks to be significantly under resourced against the value of Lendy’s loan book.
Given the popularity of the P2P model, and other crowdfunding based models, this alternative way of borrowing and lending is likely to be with us well into the future.
It will be interesting to see how the combined community of P2P investors, platforms and regulators responds to the Lendy failure.
In addition to the recent investigations by the FCA, the regulator confirmed its intention earlier this year to introduce new rules to, amongst other things, ensure platforms have adequate wind down procedures in place if they fail. There will also be rules covering (i) the corporate governance, systems and controls that platforms need to have in place to support the outcomes they advertise, (ii) assessments of investors’ knowledge of and experience with P2P investments where no advice has been given to them and (iii) the minimum information that P2P platforms need to provide to investors. These changes need to be implemented by the platforms by 9 December 2019. With an already saturated market and some platforms better equipped than others to implement the necessary changes, it may be that this leads to a period of consolidation.
The P2P platforms have yet to weather a turbulent economic cycle and further distress may emerge if the economy contracts again, potentially undermining the value of any secured assets and the ability and appetite for retail investors to invest further.
The stakeholder management required to deal with a portfolio of separate loans in the event of further platform failure will be tricky to navigate in any restructuring or insolvency scenario, notwithstanding the FCA’s requirements that sufficient back up plans for servicing are put in place in advance. The role of expert insolvency practitioners and counsel will be crucial in order to navigate the myriad of potential issues that may occur if further distress arises in the P2P lending space.An abridged version of this article appeared in Property Week on 9 December 2019.