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P O W E R E D B Y

MarketplaceLending IndexIssue 1 | 2019

Contents

Foreword 3

Marketplace lending: An overview 5

Marketplace lending sees record year in 2018, although growth slows 6

Demand from UK businesses drives market growth in 2018 10

Increasing loss rates begin to take toll on returns, as they fall to 4.1% 12

Outlook 14

Methodology 15

Media enquiries:Teamspirit PRt: 020 7360 7878e: [email protected]

Produced in association with Teamspirit. The content of this report does not constitute advice and should not be relied on as such. Specific advice should be sought about your individual circumstances before any action is taken. Data and analysis provided by Brismo.

Link Asset Services | Marketplace Lending Index • 2

Marketplace lending eschews the traditional approach of lending to businesses and individuals taken by banks. Through matching individuals and businesses who need funding, with investors who have capital to lend, tech-enabled platforms are able to streamline and disintermediate the lending process, creating a new marketplace for finance.

The inaugural Link Marketplace Lending Index, powered by Brismo (formerly named AltFi Data), demonstrates the maturation of the sector, analysing the value of loans originated by tech-enabled lending platforms. It also provides a benchmark of performance, tracking net returns, losses and yields. In doing so, it provides a clear view of both risk and reward for investors as the sector grows.

Rapid growth in the sector is bringing tighter regulation. In turn, the importance of consistent performance metrics for investors is increasing. Front and centre of the Financial Conduct Authority’s new regulations will be the need for platforms to demonstrate transparency when it comes to charges, the assessment of risk, and the pricing and value of loans. This will allow investors to fully understand the risk and reward trade-off, and to compare like with like between providers. As losses begin to weigh more heavily on returns, this is all the more important.

Many lenders have already taken the commendable step of self-policing, with the adoption of consistent measures of performance. Independent third-party verification of lenders’ data is becoming more prominent in the sector, but it is not yet universal.

Performance disclosure is even more vital because of the agent/principal conflict at the heart of platforms’ operating models, with risk being distributed to the end investor. If originators can provide investors with an efficient process, and a clear demonstration of accountability for performance, adoption will continue to expand. As the sector moves from infancy to maturity, regulation to confirm alignment of interests will provide additional reassurance for investors – especially in times of an economic downturn or tightening monetary policy. Given this should amount to more reliable funding, it is the platforms themselves that should have the most to gain from providing easy to understand measures of performance to the widest possible investor audience.

As we enter choppier economic waters, and the risk of losses rises, new lenders must also learn from established banks, and have the most appropriate loan-servicing and recovery practices in place as their loan books age. This will ensure they are able to protect investors and treat borrowers as fairly as possible whatever stage we are at in the economic cycle.

Mark Davies Managing Director Link Mortgage Services

Foreword


“Marketplace lending is beginning to fill the funding

void created by the retreat of traditional banks”


Marketplace lending: An overview

Born out of the financial crisis, and enabled by the digital revolution, marketplace lending is beginning to fill the funding void created by the retreat of traditional banks, meeting borrower demand. At the same time, incredibly loose monetary policy has suppressed yields, leading retail and institutional investors to look further afield to boost their returns.

Platforms are hindered by fewer operational hurdles than traditional banks. They do not receive the same regulation, and do not have the costs associated with legacy IT and physical branches. They do not take risk onto their own balance sheets, and although some utilise contingency funds, they do not face the onerous capital requirements faced by banks.

This has facilitated rapid growth as marketplace lending moves into the mainstream. 2018 saw a record for gross new lending, climbing above £6bn for the first time, while the much-publicised IPO of Funding Circle marked another important milestone for the sector.

However, it has not been an entirely smooth ride. UK property lender Lendy’s issue with late payments made the

headlines last year, while LendingClub’s governance failings in the US in 2016 hit confidence in the sector. Exceptions they may be, but they strengthen calls for tighter regulation, which will bring greater credibility to marketplace lending as an asset class. It also reinforces the need for an improved approach to risk management by the industry as it expands.

Greater regulation, following the FCA’s recent consultation paper, should go some way to calming any nerves relating to higher loss rates in the sector. The loss experience is increasing across lending to consumers and businesses, weighing on returns in the past couple of years. This has not yet deterred the provision of capital; attractive net returns of over 4% for 3-year term assets remain hard to find elsewhere in the fixed income universe.

2018 saw a record for gross new lending, climbing above £6bn for the first time


Marketplace lending sees record year in 2018, although growth slows

Marketplace lending saw a record year in 2018, with new gross lending reaching £6.1bn.

The final quarter of 2018 saw a total of £1.6bn in new gross lending, the highest quarterly total on record. This marks an increase of 4.5% from the third quarter total, and up 13.9% compared to the same quarter a year ago – an increase of £197m.

The longer-term growth in the sector is staggering. In 2011, the total amount lenders originated was just £92m. It now takes a shade under six days for marketplace platforms to originate this amount.

Gross new lending

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Total gross lending hit £6.1bn in 2018, rising by 20% compared to 2017

Year ended on a high, with Q4 total of £1.6bn - the biggest ever quarterly figure

Nonetheless, pace of growth is slowing as sector matures


Gross marketplace lending (£m)

Year Q1 Q2 Q3 Q4 Full year

2011 £20.2 £20.1 £23.2 £28.8 £92.2

2012 £43.9 £45.5 £56.8 £63.1 £209.4

yoy 118% 127% 145% 119% 127%

2013 £86.6 £115.3 £181.1 £210.4 £593.4

yoy 97% 153% 219% 233% 183%

2014 £269.6 £353.6 £400.8 £429.1 £1,453.1

yoy 211% 207% 121% 104% 145%

2015 £537.4 £505.4 £691.3 £745.6 £2,479.7

yoy 99% 43% 72% 74% 71%

2016 £858.3 £782.7 £877.9 £1,109.2 £3,628.1

yoy 60% 55% 27% 49% 41%

2017 £1,205.8 £1,252.2 £1,162.5 £1,413.5 £5,033.9

yoy 40% 60% 32% 27% 39%

2018 £1,360.9 £1,542.8 £1,540.7 £1,610.1 £6,054.6

yoy 13% 23% 33% 14% 20%

Nonetheless, the pace of growth is slowing as the market matures. Although 2018 saw alternative lending grow at a healthy annual rate of 20.3%, this marks a slowdown from 38.7% seen in 2017.

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Analysis of the net lending of the four largest marketplace lenders, Funding Circle, Zopa, RateSetter and MarketInvoice also suggests continued growth. Across these four lenders, net new lending totalled £280m in the final quarter of 2018, up from £248m at the end of 2017. Nonetheless, this is lower than the recent high of £297m at the start of 2017.

Positive net lending reflects ongoing growth. However, as the sector grows and matures, so we expect net lending will slow; a growing number of outstanding loans means the total value of repayment is climbing sharply each year, especially with an average loan term of just 36 months.

Indeed, across these four lenders, the value of outstanding loans has reached £4.5bn, more than doubling since the start of 2016, and an astonishing 42 times the £106m outstanding at the end of 2011.

For the full market, we estimate the value of outstanding loans stands at around £6.3bn. Relative to the scale of bank lending to consumers and SMEs that takes place each year, there is still scope for significant expansion. By comparison, UK Finance’s data show the value outstanding loans to SMEs is currently £102bn1, while the value of outstanding consumer credit stands £216bn, according to the Bank of England2. Given marketplace lending’s limited penetration of both the consumer and SME finance market, despite its expansion the size of the opportunity for further growth remains substantial.

1 UK Finance SME Update, August 2018. Data refers to total outstanding lending to SMEs though loans and overdrafts at the end of Q2 2018

2 Bank of England, 30 September 2018. Consumer credit excludes Student Loans.

Value of outstanding loans among the four largest lenders

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“Relative to the scale of bank lending to consumers and

SMEs that takes place each year, there is still scope for

significant expansion”


Demand from UK businesses drives market growth in 2018

Invoice finance lending grows by 105%, accounting for £1.1bn in 2018

Consumer and property lending sees slowest growth, with property lending set to increase just 2.1% this year

Invoice finance is a way for businesses to borrow against money they are due to improve cash flow, bring forward investment or meet other financial needs. Invoice finance platforms was the key driver of growth in 2018 as SMEs looked beyond traditional banks for their funding. Invoice finance lending increased by 104.8% compared to 2017, and accounted for around £1.1bn of the full year total. This compares to just £535m in 2017, and £310m two years ago. The growth of invoice lending has been typified by the expansion of MarketInvoice, the largest lender in this category, which saw Barclays take a minority stake in its business in August, as it seeks to roll out access to the platform to its SME client base.

Broader business finance, which may involve companies borrowing to invest, buy new premises, make acquisitions, or indeed refinance, has seen the next largest growth. It broke the £2bn lending barrier for the first time in 2018, with gross lending climbing by £368m to £2.1bn. Nonetheless, it has seen slower annual growth of 20.9%, down from 50.4%.

Lending to consumers – frequently to fund big-ticket item purchases, home improvement or to facilitate debt consolidation – has seen far steadier growth too. In 2018, it rose by just 4.0% compared to a year ago, climbing to £1.9bn, reflecting a more cautious approach from consumers towards their spending and borrowing.

Property lending trails the other categories, with growth of just 2.1% in the year. The smallest of the sectors, it can involve secured lending against property to fund development, provide bridging finance or fund buy to let investment. With £961m of annual lending, it actually witnessed lending levels fall year on year in the first half of 2018. The troubles of the wider housing market, with weakening house price growth in many areas, sluggish transaction activity, and higher taxes for landlords is no doubt a factor. However, performance across the sector is not uniform by any means. The likes of Landbay, LendInvest and CrowdProperty are still seeing solid growth. By contrast, Lendy has faced well-publicised issues with arrears and defaulting loans that is likely to reduce appetite from its investors in the property lending space in the short-term.


Annual gross new lending, by category

Business Property Consumer Invoice

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2018 lending, by sector (£bn)

Invoice £1.1bn

Property £1.0bn

Business £2.1bn

Consumer £1.9bn

Annual growth by sector since 2016

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Increasing loss rates begin to take toll on returns, as they fall to 4.1%

Assessing the investment performance of marketplace loans is not as simple as analysing the typical gross yield an investor can expect. Across the industry, there is considerable variation in fees, terms, default and recovery rates, let alone interest rates. Our lending returns index accounts for all of these moving parts to provide a single benchmark figure for the industry; i.e. the actual return an investor will have enjoyed over the preceding 12 months. This is achieved by constructing a portfolio with a fully diversified exposure to all of the outstanding loans of the constituent origination platforms. Importantly this portfolio takes an equal exposure to each time cohort. This ensures that performance is not distorted by the effect of variations in the growth of loans outstanding and creates a consistent reference point for performance comparison3.

Net returns across the marketplace lending sector have been falling since their most recent high of 6.4% in the second quarter of 2016. The latest data shows they stand at 4.1%4, down from 4.5% in the second quarter of 2018, and 5.4% in the third quarter of 2017.

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Net returns stand at 4.1%, as losses weigh on total

Net yields stable at 7.2%

Experience of losses increases across sector, while fewer loans protected by contingency funds

3 See methodology for detailed explanation4 The latest data available for the returns index is Q3 2018, due to a lag in the reporting of the data.


There are two factors at play. Firstly, we have seen rising losses on loans across the market, largely among higher risk borrowers with higher interest rates. A weaker economic backdrop has affected the ability of a growing minority of businesses to meet the terms of their loans. In the consumer segment, the deterioration is more visible among older cohorts of loans, reflecting the pressure consumer finances have been under from prolonged weak wage growth and inflation; indeed, personal insolvencies reached a seven year high in 2018.

The increased loss rate has been exacerbated by changes on a technical level by lending platforms. A smaller proportion of loans are covered by a contingency fund, following Zopa’s withdrawal of its Safeguard mechanism last year. 43% of index constituents’ loans were covered by a contingency fund at the end of 2016. This has fallen to 22%. While this has provided some support for the interest rate offered, it also has made loss rates less flattering, with fewer defaults being covered by contingency.

Even with the average loss rate increasing, however, the current net interest on a typical loan covers net losses by a multiple of 2.35x, and the overall return of 4.1% continues to compare favourably against other short-duration fixed income investments.

The components of net returns: yield and loss

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Yields Loss

There are two main drivers for changes to net returns: the net yield and the loss rate on loans. The net yield takes into account the initial interest rate, platform fees, and the costs of contingency funds that selected platforms adopt to add additional protection against defaults. The loss rate on loans is influenced by default and recovery rates, as well as the proportion of loans covered by a contingency fund.

Net yields have remained steady since the third quarter of 2017, and stand at 7.2%, up slightly from 7.1% in 2017. Slightly higher rates in the consumer space have offset slight declines in the business and invoice finance segments.

By contrast, the average loss on loans has increased, reducing the net return by 2.9 percentage points. This has worsened since the end of 2016, when net losses reduced returns by just 0.9 percent points.


Outlook

Based on current trends, we estimate that gross marketplace lending will grow by a further £1.2bn in 2019, climbing to £7.3bn in new loans. This represents a similar pace of growth as 2018, growing by 20.0%.

However, platform lenders do face some uncertainties with regard to the economic and regulatory backdrop.

Brexit is an ever more prominent cloud on the horizon. We have already seen loss rates increase, and the economic fallout of a turbulent Brexit has the potential to hit borrowers. Should consumers face rising unemployment or businesses struggle, losses would climb further. We do not envision this will pose a systemic risk for the market. Unlike traditional banking, platforms are not leveraged; there is no multiplier effect. Nonetheless, there is no room for complacency. If defaults continue to climb, it will place a new level of strain on marketplace lenders’ risk management strategies, testing their loan servicing and recovery approaches in a downturn. Equally, any economic slowdown will affect pricing. As the risk of loss increases, investors will expect greater prospective returns. This could also test the diversity of the funding model, given the narrowness of institutional adoption, which at present is limited to a relatively small list of funding partners.

Further regulation is coming too. This should not be seen as a threat for the industry. The UK’s marketplace lending sector is the only market to boast a dedicated regulatory regime, which has added an additional layer of credibility for investors. Whilst there may be additional restrictions on marketing to retail investors, a key outcome of the FCA’s consultation is likely to be an improvement in the transparency of performance reporting across the industry, allowing investors to assess the risk and value of loans across platforms. This should result in improved rates of adoption as fiduciaries are prepared to allocate capital with increased confidence.

The industry has already come a long way on this front, but standardised metrics for assessing risk with returns on loans would help marketplace lending reach the next stage of its development as an asset class. Ultimately, we expect regulation to support sustainable growth for the sector.

Gross annual new lending, by category


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Methodology

Unless stated otherwise, all data within the report is based on data and analysis by Brismo. Origination data is either reported directly to Brismo by originators or is sourced from data published online by the originators themselves. The value and volume of marketplace lending reflects data from 28 lenders, accounting for more than 90% of the market. 2019 is a projected estimate, seasonally adjusted and, based the latest available data and historic trends.

The lending returns index measures the returns available from a representative sample of tech enabled lenders in the UK. These platforms represent over 70% market share of the UK marketplace lending sector. Index values are published as an annualised return, measuring what an equal time-weighted exposure to every loan originated by the participating platforms would have generated over the preceding 12- month period. Time-weighting ensures that the index reflects a perfectly diversified loan portfolio, which is equally representative of cohorts of all ages. The return has been calculated after fees and is expressed net of losses and recoveries. Due to the lag in the reporting of the data, the latest figures available for the returns index refer to Q3 2018.

www.brismo.com The standard in lending performance

For information on the Lending Index Methodology, please contact us at:

Email: [email protected] Telephone: +44 (0)20 7153 1218

https://brismo.com/wp-content/uploads/DocsM/Brismo_%20Returns%20Index%20Methodology%203.0.pdf

mailto:[email protected]

For all enquiries please contact:

Teamspirit PRt: 020 7360 7878e: [email protected]

Link Asset Services is a trading name of Link Market Services Limited. Registered office: The Registry, 34 Beckenham Road, Beckenham, Kent BR3 4TU. Registered in England and Wales No. 2605568.

For further information, including the legal and regulatory status of this company, visit www.linkassetservices.com/legal-regulatory-status Produced in association with Teamspirit. The content of this article does not constitute advice and should not be relied on as such. Specific advice should be sought about your individual circumstances before any action is taken.

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