This peer-to-peer founder thinks 2017 will be a crunch year for the industry and firms could fail

Chirag Shah, CEO Nucleus Commercial Finance.Nucleus Commercial Finance

LONDON — The founder of a British peer-to-peer lender believes more platforms will go bust in 2017 as poor risk assessment standards come back to haunt businesses.

Chirag Shah, founder and CEO of Nucleus Commercial Finance, told Business Insider: “The easiest thing in the world right now is getting the money out. The difficult thing is getting it back. Everyone’s done the easy part of building the loan books. Now let’s see who can get the money back.”

Shah highlighted the collapse of UK platforms Funding Knight and Legion Trade Finance in 2016 and said he expects more closures of peer-to-peer small business lending platforms in 2017, saying “there is no room” for the number of platforms in the market. AltFi, a widely respected data provider for the alternative finance industry, collects data on 26 peer-to-peer lending companies in the UK but the true number of platforms in the space is likely higher. Many of them are relatively small scale.

Shah says: “The majority of them were launched about 4 to 5 years ago but the real growth happened in the last 2 years. So now, starting next year, a lot of those portfolios will start maturing.

“You can see a lot of other platforms in the real estate space and stuff struggling, changing a lot of things, letting people go. You’re already starting to see the thing come in.”

Online property crowdfunding platform Property Partner cut 29% of staff earlier this year and peer-to-peer mortgage lender Landbay’s lending volume collapsed by 95% in the third quarter of this year.

Conrad Ford, founder and CEO of Funding Options, told Business Insider he agreed with Shah’s view that there would likely be more collapses, saying: “It’s relatively inconceivable that we won’t have some platforms going under.” Funding Options is a platform that helps small businesses get the right financing for them by comparing lending options across the industry.

The question is whether all the platforms have sufficient working capital or have what it takes in terms of the loan economics. The straight answer is no. — Conrad Ford, Funding Options

Ford says: “The question is whether all the platforms have sufficient working capital or have what it takes in terms of the loan economics. The straight answer is no. There will be more Funding Knights because this an industry that supports scale. Just look at how much money some of the big platforms are churning through to survive. They’ve got scale and they’re still not breaking even.”

As Business Insider pointed out earlier this year, Britain’s two biggest peer-to-peer lenders, Zopa and Funding Circle, have collectively made a loss of over £50 million since 2005 in the course of operating their businesses. Ford says: “Eventually investor confidence and investor cash will dry up.”

Peer-to-peer platforms allow people or institutions like hedge funds and insurers to invest directly in loans to people or companies by bringing borrowers and lenders together in an online marketplace.

The Financial Conduct Authority (FCA), Britain’s finance regulator, alluded to concerns about platforms going bust earlier this month. The regulator concluded after a six month review of the sector that one of its biggest concerns was that “the plans some firms have for wind-down in the event of their failure are inadequate.”

Shah, a former banker who worked for Merrill Lynch and Wachovia, blames poor credit assessment in much of the market for the problems. He claims he is seeing “a very big red flag” when it comes to underwriting standards, such as companies taking on multiple loans from different platforms.

He told BI: “We know [due diligence] is not what it should be. We have interviewed risk guys from a variety of these platforms. When you interview them you learn a lot about their underwriting processes. In most cases, we are learning that they are just not up to the standard. In certain cases, it is just really appalling and non-existent.”

A spokesperson for the P2PFA, the trade body for the peer-to-peer lending sector, told Business Insider: “The credit risk models used by P2PFA platforms are broadly similar to those which traditional lenders have in place, using data from credit reference agencies and other sources.”

Rhydian Lewis, RateSetter CEO.RateSetter

Shah didn’t name specific platforms but in a yet to be published blog seen by Business Insider Shah he writes: “RateSetter, for example, reported a default rate of 2.81% on loans originating in 2014: a number that’s both above expectations (2.07%) and potentially capable of eliminating the company’s provision funds.”

A spokesperson for RateSetter told Business Insider it has “robust underwriting standards, and publish detailed information for every loan we’ve written – compare this unprecedented level of transparency with the wider financial industry.” The spokesperson added that its provision fund is “currently large enough to cover expected losses with money to spare.”

Shah added that problems are being made worse by the increased stratification of the market. He told BI: “The P2P space is forming a hierarchy right now. If you leave the top 3 or 4 platforms out, all the other platforms are basically seeing the deals that they are not doing. They are getting third tier or fourth tier deals which have been turned down by banks and turned down by other platforms.

“The moment you get to that level, your processes need to be even more stringent. Do they have underwriters? Yes. Do they have the right quality underwriters with the right experience? No, because they cost a lot more. It’s kind of a cycle. They’re chasing volume, they’re getting the worst deals, but they don’t have the personnel to deal with those deals.”

Ford says that he expects platforms to struggle due to poor loan economics based on unrealistic expectations of growth, rather than underwriting issues.

Ford told BI: “Do I think [underwriting problems] are endemic across the industry? No I don’t. The thing about SME lending is there are an enormous amount of relatively small underserved pools of value. There’s dozens of special niches.

“The problem is when people begin to make ridiculous claims that there’s a £10 billion a year lending opportunity out there. There really isn’t. There’s lots of £50 million lending opportunities.”

Shah’s Nucleus Commercial Finance is a peer-to-peer platform that lets institutions such as banks, hedge funds, family offices, and insurers lend money to small businesses. Set up in 2011, Nucleus has lent over £407 million and claims to have lost only £5,800 to date.