Those of you who have been following my recent commentaries will know I’ve been spending a lot of time looking into the emergence of alternative and disintermediated funding solutions for small and midcap corporates, a key focus of financial policy across Europe.
I’ve looked in detail at European private placements as well as efforts being made by policymakers to accelerate the return of securitisation as a risk lay-off and regulatory capital relief tool to facilitate the resumption of lending by banks.
In truth, I’ve been broadly sceptical about the extent to which traditional capital markets are set up to meet the needs of the vast majority of small and micro-caps that dominate the European SME landscape, not just because of the small amounts of cash they need on an individual basis but because the institutional buyside sector is not structured to deal with them on a one-to-one basis. Banks are invariably the only realistic option for most small companies.
But one area that is attracting a huge amount of attention at the moment – including mine – is the growth of peer-to-peer (P2P) business lending. It’s found its way into the work streams of financial policymakers as well as onto the agendas of regulatory agencies.
The UK alternative finance market provided over £1bn in business finance to over 7,000 SMEs last year, according to a report published in February by EY and the University of Cambridge. That’s equivalent to 2.4% of the total bank lending to SMEs. OK it’s small but that number is expected to grow at an accelerated rate in coming years.
Collecting data from 255 alternative finance platforms, the report – Moving Mainstream: the European Alternative Finance Benchmarking Report – pointed to the fabulous growth rates the sector has experienced in the past three years. The European market grew, it said, by 144% last year to €2.96bn (US$3.25bn). Within that, P2P business lending in Europe ex-UK hit €93.1m in 2014, tiny but sporting average growth rates of 272% over three years.
“For many SMEs, the speed with which they are able to obtain business loans, the often more flexible and attractive terms of financing (e.g. no penalty for early repayments on many platforms), as well as transparency and ease of use, are determining factors that make peer-to-peer business lending a viable business funding alternative,” the report’s authors wrote.
They estimate that the Europe ex-UK alternative finance market provided €385m in early-stage, growth and working capital financing to nearly 10,000 European start-ups and SMEs in the last three years, €201.43m of which in 2014. The report reckons the European alternative industry is on track to grow beyond €7bn this year.
Institutionalisation
P2P lending is increasingly attracting the attention of mainstream lenders and investors (including high net-worth individuals, mutual and pension funds, hedge funds and family offices). As institutional interest in the product gathers pace, the amount of capital available will, by definition, grow and I reckon the product will develop into an interesting solution to the small company funding dilemma.
ESO Capital’s partnership with ThinCats, which hit my inbox a couple of weeks back, looked on paper to be a neat deal. The P2P secured business lender struck a deal with the SME-focused European special situations fund to underwrite a regular series of deals on the platform. The deal will initially involve £20m-£50m but both parties expect that figure to rise significantly over the next few years. ThinCats said the partnership would allow it to auction loans of up to £5m or more.
“With institutional investors starting to invest and diversify through those online platforms, corporates are beginning to experiment with various forms of crowd-funding and crowd-sourcing, and banks themselves are getting involved with peer-to-peer or ‘marketplace’ lending; alternative finance is creating ripples and moving increasingly into the mainstream,” the EY/Cambridge report noted.
Bruce Davis, a director of the UK Crowdfunding Association, counselled caution on the institutionalisation question: “Platforms need to ensure that the ‘crowd’, which we fought so hard to keep in the frame, is not, ironically, crowded out by big money,” he wrote in the EY report.
“The experience so far has been positive, with most platforms taking the view that big money should not disadvantage the small investor in any way. This is important, because the big differentiator of the alternative finance sector is the fact that no-one can or should throw their weight around and corner the market, or gain advantage through early access to information.”
His comments echo the disquiet that’s being expressed elsewhere, where some see the institutional and bank interest in alternative finance as a cynical takeover by Big Bizness of a grass-roots social movement that grew out of the rubble of the global financial crisis and deep mistrust of the banks. Talk of banks ‘infiltrating’ P2P platforms with a returns-based agenda and undermining the sector’s disruptor influence is perhaps a little conspiratorial, though.
Bringing the story firmly into the wholesale capital markets arena – and perhaps neatly tying together two strands of the EU’s Capital Markets Union debate – is the prospect of P2P securitisation. I can see it developing – slowly perhaps – into an alternative ABS asset class in Europe as the number of loans and loan volumes flourishes.
A number of P2PABS deals have been done off the Prosper, Social Finance and Lending Club platforms in the US. Whether or not European trades will achieve the high-quality label under the European Commission’s in-process proposals is another story but it’s an interesting notion, nonetheless.
As a final note, the one thing that I suspect will drive interest in P2P loans and receivables is the same thing every investor in Europe is craving: yield. Unsecured P2P facilities in particular may be high-risk but then again who wouldn’t look at investment opportunities or receivables flows yielding high single-digit or double-digit percent returns as a small part of an otherwise flat-lining portfolio? Bring it on!
