14 - 07 - 2015 | |
Peer-to-peer lending is becoming a formidable asset class among those with an appetite for alternative investments. Personal Wealth looks at the burgeoning industry.
Peer-to-peer (P2P) lending has grown into an alternative asset class for investors in recent years. Its growth is mainly due to the implementation of the Basel III requirements in 2013. The regulatory framework for the global banking industry requires banks to increase their capital holdings, and this has resulted in stricter loan criteria and fewer loan approvals.
According to Pawel Kuznicki, CEO of Singapore-based Capital Match, one of the first P2P lending firms in the region, the industry caters for individuals and small and medium enterprises (SMEs).
"P2P lending is an alternative method of attaining business capital, especially for individuals and SMEs, which are underserved by banks, given the higher risk and lower loan quantum [compared with larger companies]. Thus, P2P lending primarily fills this gap and aims to meet the growing demand for working capital from borrowers and for higher yields from investors."
In P2P lending, commercial or consumer borrowers source funds from a larger group of unrelated investors to gain the capital they need, usually through an online platform. Kuznicki says this form of lending is essentially banking but without a bank as an intermediary.
"P2P lending platforms, such as Capital Match, aim to provide an alternative financing source to commercial or consumer borrowers from private investors, offering the latter group an attractive return on the capital," he explains.
"It is an alternative way to channel funds from people who have excess funds to those who need it. It happens through an online platform where borrowers can request for funds and lenders can pledge their capital for a defined interest rate."
All this sounds like a good idea, and the numbers seem to fall in line. According to PricewaterhouseCoopers' analysis in its February publication, Peer Pressure: How Peer-to-Peer Lending Platforms are Transforming the Consumer Lending Industry, the market is expected to reach US$150 billion (RM572.3 billion) by 2025. To arrive there, the lending platforms will need to "capture 10% of the US$800 billion in revolving consumer debt and 5% of the US$1.4 trillion of non-revolving consumer debt held by financial institutions".
Some big names have been getting on board the P2P lending train. In 2013, Google led a US$125 million investment in Lending Club, valuing the business at US$1.55 billion. And last month, The New York Times reported that Goldman Sachs was planning to introduce its own channel, offering small consumer loans "that can help you consolidate your credit card or remodel your kitchen".
UK-based Zopa, the first in the world to offer P2P lending services online, stated in its March 9 press release that it had "surpassed £750 million (RM4.4 billion) in loans to UK customers [that week], and expected to pass the £1 billion mark this summer". At the time, the company had lent money from more than 58,000 individuals across the UK to more than 107,000 individual borrowers, who used the money to purchase cars, make home improvements or pay off existing debt.
Lending Club, a US-based P2P lending firm, has given out more than US$9 billion in loans since it was founded in 2006. It gave out loans of more than US$1.6 billion in 1Q2015 alone, which was over 450 times more than what it lent out in 1Q2013.
For the savvy investor looking out for the next potential investment vehicle, P2P lending might be worth a look.
While the concept might sound like the latest fad, P2P lending has been around for a long time - long before banks emerged and became the norm. The Lending Club's blog states that this was how lending was carried out centuries ago, when people borrowed money from each other to invest in a business. What P2P lending has done is simply to commercialise the process and, with the use of the internet, make it available to pretty much everyone and bypassing conventional banking in the process.
P2P lending has taken off because of its numerous advantages. First and foremost, it is easy for an investor to access these platforms. Capital Match only requires a minimum of S$1,000 (RM2,816) for lenders to get started. MoolahSense, another P2P lender in Singapore, has the same investment requirements. Zopa, meanwhile, says on its website that £10 is all you need to start investing.
This is cheaper than investing directly in Singapore bonds, where the minimum investment amount is S$250,000. A one-year Malaysian government bond typically requires an investment of about RM1 million, although the figure can vary depending on market dynamics.
Another advantage of P2P lending platforms is the exposure to a wide variety of local SMEs, which offers investors portfolio diversification. Capital Match's platform, according to its website, works with Singapore-based SMEs with revenues of S$1 million to S$10 million.
"Investors in P2P lending platforms need to understand if the company has sufficient cash flows to cover monthly repayments. Then, depending on the investor's investment strategy (fixed income versus equity versus real estate and so on), he should allocate a portion of his capital to one or the other, or both," says Kuznicki.
"Both offer additional diversification to a typical portfolio - exposure to the SME market does not have to be correlated to the stock market or real estate."
The real hook for investors will be the attractive return on investment that the P2P lending platform can offer, which can range from 3.8% to 25%, depending on the platform, tenure and how returns are measured. Zopa projects an annual return of 3.8% for a three-year period. The Lending Club, according to its website, registers an adjusted net annualised return of about 8.5%, although this figure will vary depending on factors such as the credit quality of the loan involved and the underlying risk of the borrower. MoolahSense offers a return of up to 20% per year.
Capital Match offers between 20% and 25% return per year, says Kuznicki. Loan periods can be as short as a few months to several years. Its main focus, however, is on short-term loans of 6 to 12 months. Zopa, meanwhile, can facilitate loan terms of one to five years.
Kuznicki points out that a listed corporate bond in Singapore, even with leverage, only provides an expected annual return of 15% at most. By comparison, a few local analysts say a one-year Malaysian government bond sees yields of about 3% annually.
P2P lending does not come without any disadvantages, however. Kuznicki says investors have to realise that because SMEs are sub-perfect rated, there is a higher risk of default present. By comparison, listed bonds have a lower risk profile. "Listed bonds obviously have a lower risk profile than P2P lending, which has higher associated risk," he says.
Since most SMEs fail to get loans from banks and can only take on unsecured loans, the risks are higher, says Kuznicki. Thus, it is only right to charge them higher interest rates when they gravitate towards P2P lending platforms for their working capital. Borrowers have to deal with higher interest rates to compensate for the higher risk they present.
"The interest rate is compensation for the capital, adjusted for the risk involved - if the risk is higher, the interest rate should be higher as well," says Kuznicki. However, if there are economies of scale, there is a possibility of interest rates being lowered in the future, he adds.
"The operational cost of running an online platform is lower than the cost of running a bank. If more SMEs are attracted to this source of capital, we can expect a range of interest rates, from below the rates that banks charge (for bank-rated SMEs) to higher rates for risky businesses without any collateral."
Tho Li Ming
In its efforts to further liberalise the fund management industry, the Securities Commission Malaysia (SC) announced that the regulations for setting up boutique fund management companies will be relaxed.
In its July 8 press release, the SC said parties with niche fund management expertise can now be licensed as boutique fund management companies. They would only require a paid-up capital of RM500,000, compared with RM2 million required for a full-fledged fund management licence.
Prior to this, there was no licence category available for boutique companies. Under the new licence, boutique fund management companies are allowed to manage assets of up to RM750 million, with a clientele of not more than 50 sophisticated investors.
In a recent technical briefing for the media, the SC explained that the relaxation of these rules is aimed at encouraging entrepreneurship in the industry from both local and foreign parties. In its press release, the SC also announced that the restricted dealing licences has now been broadened to include the offering of securities and over-the-counter bonds via online platforms, "giving investors wider access to the capital market through innovative business models driven by technology".
Prior to this, the licence was restricted to the dealing of unit trust products. With this new ruling, online platform providers, for example, will be able to offer equities and retail bonds. Nevertheless, they will still be required to work with licensed intermediaries to execute clients' orders.
In addition, the range of permissible activities for fund management companies will be broadened to provide investment advice to clients. With this, they will now be allowed to provide non-incidental investment advice to existing clients without the need for a separate investment advice licence. Previously, they were only allowed to provide investment advice services if it was incidental to the fund management activity. Under this new ruling, existing clients can ask fund managers for investment advice alone, without the latter having to execute it.
Marketing activities by licence holders will also be liberalised. Marketing, sales and client servicing activities by fund management companies can now be undertaken by representatives registered with the SC, in addition to the licensed representatives.
As at May, the total assets under management in Malaysia stood at RM662 billion, compared with RM377 billion in 2010. The fund management industry is the fastest growing segment in the capital market, registering a compound annual growth rate of more than 10% over the last five years.
Given the higher risk of default, P2P lending platforms have put up numerous safeguards to protect the investor. For Capital Match, the following measures have been put in place.
"If a default were to happen, we would employ a debt collection agency to attempt to collect the debt from the borrower. There are other measures in place. The directors of the borrower have to provide personal guarantees so that the debt can be collected from both the company and its directors," says Kuznicki.
"If the debt collection is unsuccessful, we would then advise lenders if they should start legal action against the borrower. The cost of debt collection is on us, but the cost of subsequent [if any] legal action has to be borne by the lenders. In the future, we will introduce secured loans to provide better security to lenders."
On the company's website, it states that a late payment fee of 1% on the outstanding principal is charged to the borrower. It also "charges a late payment interest of 0.1% per day on the outstanding principal payable to lenders for each day the payment is late until it is settled".
In the UK, numerous measures have been taken to reduce the risk of lending to subprime borrowers. For instance, Zopa's website states that it has a Safeguard Trust to protect investors. Firstly, it reassures investors that they do not need to take action if a borrower misses a payment as Zopa will follow up with the borrowers.
If the loan is four months in arrears, the contracts "are assigned to Safeguard to claim for the outstanding loan amount. Safeguard usually pays the claim, but does reserve the right not to. In this case, it will seek to recover the amounts owed on your behalf".
Due to its infancy, at least within Southeast Asia, P2P lending remains largely unregulated. Capital Match is under the purview of two regulatory bodies in the island republic - the Monetary Authority of Singapore and the Ministry of Law.
"However, currently there are no specific regulations for P2P lending, though we expect regulations to emerge over time," says Kuznicki.
Besides government regulations, other industry-related bodies may emerge to provide their own guidelines for the burgeoning industry. The Peer-to-Peer Finance Association in the UK, which seeks to represent member P2P platforms, among others, have provided a set of operating principles for members to comply with.
These operating principles are essentially regulations to ensure the "orderly operation of peer-to-peer finance platforms". More specifically, they cover areas such as the minimum operating capital requirements, appropriate credit and affordability assessment as well as appropriate anti-money laundering and anti-fraud measures, among others.
The very notion of peer-to-peer (P2P) lending appears to place such platforms as competitors of banks as they vie for the attention of the same lending and borrowing audience. But Pawel Kuznicki, CEO of Singapore-based Capital Match, disagrees. He believes that the future will be one where both traditional banks and P2P lending firms co-exist and serve the market segment they are best suited for.
"P2P lending can complement traditional banks. Most of our customers have difficulties getting bank loans, thus they are looking for an alternative source of funding," he says.
"We believe there will be space for both banks and P2P lending companies. P2P lending emerged because banks were not serving a large segment of customers. We believe that in the next 5 to 10 years, SMEs will be to a large extent served by P2P lending platforms, whereas medium to large companies and multinational corporations will be served by the banks."
While Capital Match's platform is currently limited to Singapore residents with a local bank account, the company plans to expand its offering to other countries in the near future, including Malaysia.
"As soon as we implement a trust account, we will be able to accept investors globally. They would be vetted first by the trust company we are working with and if approved, they will be able to transfer funds to the trust account and start investing."
The peer-to-peer (P2P) lending concept sounds very much like the crowdfunding concept. However, they aren't exactly the same. Although both use online platforms for fundraising, crowdfunding offers either equity or rewards in return for capital, whereas P2P lending centres around issuing debt and receiving regular repayments of principal, which is pledged for at a defined interest rate.
Capital Match CEO Pawel Kuznicki explains that while the underlying concept involves the idea of businesses attaining funds by sourcing funds from a larger pool of unrelated investors, there are differences.
"The primary difference between crowdfunding and P2P lending is that the former is where investors focus on receiving equity in exchange for capital, while the latter focuses on issuing debt and receiving regular repayments of principal and interest. They have different risk-return profiles and serve a different purpose to SMEs," he says.
"Investment in equities rests upon an expectation of high growth from the company that will result in better valuations and capital gains for the investor. Lending has a limited upside (limited by the agreed interest rate), but it gives better protection to the investor (creditor) and does not require an impressive growth of the company, but rather stable cash flows [to cover debt repayments]."
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