Peer-to-peer lending lacking mum and dad investors
With interest rates at record lows, it can be hard to know where to put your savings.
Open a bank account and you might get 3 per cent interest.
But what if someone suggested lending it to your neighbour?
Put that way, it might not sound like an attractive proposition. But peer-to-peer lending services that connect borrowers with willing investors say business is booming.
The industry is nascent in New Zealand but has been gaining traction for years overseas.
It is estimated that the amount of lending done by United States peer-to-peer lenders is doubling every nine months.
The online platforms do not carry any of the loans on their own balance sheets.
Instead, they offer the infrastructure to matchmake investors with credit-checked borrowers, and charge a fee for the service.
The Financial Markets Conduct Act made peer-to-peer lending possible in New Zealand. The first to enter the market, Harmoney, recently celebrated a year in operation.
Squirrel Money, an offshoot of the mortgage broking firm of the same name, and Lendme have been licensed by the Financial Markets Authority but are yet to start operating.
But while Harmoney is trumpeting its early successes, it is gaining far more traction with borrowers than it is with investors.
Harmoney has made more than $100 million in loans over the past year, had more than 70,000 loan inquiries and 7500 loans are currently active.
It expects to have its first $2m day by the end of November.
Just over half the loans issued have been for debt consolidation and about 15 per cent for home improvement.
Chief executive Neil Roberts said borrowers were attracted by the convenience and ease of the online operation.
"It's 24/7 and non-judgmental, you can do it online, we're making it as painless as possible."
But Harmoney has strict lending criteria. Only 20 per cent of loan applications are approved.
The interest rate you pay depends on how risky Harmoney thinks you are. It has 30 risk grades, from A1, where you pay 9.9 per cent interest, to F5, where you pay 39.99 per cent. Only 1 per cent of loans are F5.
Roberts said the average Harmoney borrower was a male in his 40s, with a mortgage and household income of $90,000 and above.
This is where it gets interesting. Even that average borrower should be eligible to borrow from most lending institutions at competitive rates. Those who are an even better credit proposition almost certainly could.
But the average weighted borrower rate from Harmoney is 18 per cent, excluding fees.
That is significantly more than a borrower would pay if they topped up their mortgage.
Even for those for whom that is not an option, ASB has unsecured debt consolidation loans at 15.95 per cent and a secured personal loan option at 12.95 per cent. Kiwibank offers unsecured personal loans from 14.99 per cent.
Roberts said many mortgage borrowers chose Harmoney because their loans were at the maximum the bank would give them, or they were fixed and did not want to break their loans. "Or they don't want their bank to know."
Many mortgage-holders would be rewarded on the platform with lower interest rates if their credit was good, he said. That meant they could pay rates closer to 12 per cent.
Massey University banking expert David Tripe said some borrowers might not be able to convince their banks to lend to them.
"Some people have some completely hair-brained schemes and the bank is going to say 'don't be so bloody silly'. Or they may think it's cheaper than borrowing on credit cards. It also might just not occur to them to go to the bank."
To borrow from Harmoney a borrower must pay a platform fee of 2 per cent to 6 per cent of the loan amount, depending on how risky the loan is.
Loans are contracted for 36 or 60 months but can be paid off early.
Harmoney has had to fight harder to get investors' attention.
Harmoney has 10,000 registered investors, of whom 3000 are active – "who come to the site more often than they use their toothbrush, two or three times a day".
But 80 per cent of the lending is still backed by institutions such as Heartland bank. August was the first time 50 per cent of the lent money came from individual retail investors.
Roberts said the company was targeting a risk-adjusted average return of 12 per cent a year after fees and any losses and before tax
He said most of the money that was being invested in Harmoney was coming from term deposits, where investors earn between 2 per cent and 4.6 per cent if they are willing to lock their money away for two years.
Investors have an average $6000 in their Harmoney accounts but the largest individual retail investor put in $650,000. The minimum investment required is $500.
Harmoney investors directly wear the risk of a credit default.
Roberts said Harmoney did the best it could to quantify risk and rank its borrowers accordingly.
Investors can choose to only lend to the A-ranked borrowers but that will limit the returns they get.
Investors "fractionalise" their investment – dividing it up into $25 units that are spread across a number of borrowers' loans, to spread their risk.
After a year, Harmoney's has a loan default rate of 4.5 per cent and Roberts said it had been static at that level for four or five months.
Tripe said investors needed to be careful.
"It's not clear what happens when loans go bad. Since the finance company events people might understand the relationship between risk and return a bit better but it is still not necessarily a very good understanding."
He said while the economy had been good, it was hard to get a clear understanding of what would happen to Harmoney's investors in a downturn. They could be in for a shock, he said.
William Cairns, director of General Finance, agreed. "I'm not a big fan of peer-to-peer lending. It has got the potential to be the next subprime mortgage disaster."
He said unsecured loans were problematic and dividing risk across multiple loans did not make the loans any better.
"It's like the subprime mortgage market, the idea you can package up the loans and sell them. You can't get the returns from the bank or bonds at the moment and people say peer-to-peer has the higher return but it's risky as hell."
Cairns said peer-to-peer lending was likely to become more of a risky investment as competition grew in the market.
"The quality of the credit will go further and further down."
Roberts said Harmoney wanted its investors to educate themselves on the site.
"We wouldn't want people to put their life savings in, we want them to be careful and enjoy the experience."
Roberts said there was a risk of problems with other peer-to-peer platforms if they were set up by people with insufficient experience or inadequate systems.
New Zealand Bankers Association chief executive Kirk Hope said would-be investors should consider the levels of trust and reputation associated with peer-to-peer lenders.
"Most New Zealanders already have a relationship with a bank they trust. Banks work hard to develop and maintain that customer trust and satisfaction.
"Non-traditional players are going to have to work pretty hard to build their own reputation when they're coming in to compete with banks. That's especially the case in the New Zealand context where many finance companies collapsed through the GFC."
Hope said peer-to-peer lending would present a challenge to traditional lending models. How successful it was in the long term in New Zealand would depend on how well it worked for individuals, he said.
"One issue for banks, as the market evolves, may be around flexibility in being able to respond to peer-to-peer lenders.
"The regulatory framework will need to keep up with these changes and not disadvantage traditional lenders. We don't see that as a problem at this stage."