Peer-to-peer lenders have grown fast in the US and UK in recent years, thanks to low interest rates, dissatisfaction with meagre returns on bank savings and disaffection with banks generally.
Leading marketplace lenders such as Zopa, Funding Circle, RateSetter and Lending Club are now inspiring a second generation, seeking to fine-tune the business model of lending outside the traditional banking system.
One such is Landbay a UK-based peer-to-peer lender founded in 2013 by economist John Goodall and property finance analyst Gray Stern that focuses on loans secured against rental property.
“At the time we founded Landbay peer-to-peer lending in the UK had mostly channelled investors to unsecured consumer or SME loans,” says Goodall. “While those forms of credit have performed well since the financial crisis, at some point there will come a change in the economic environment and they will perform much less well. Our idea was to offer our investors access to an asset class with proven performance through the cycles, one that is both scalable and resilient.”
The £30 billion a year buy-to-let mortgage market was that starting point. Though a big market, it is still not a core one for the big UK banks. “Residential mortgage lending is both heavily regulated and low margin, and it would be hard to build a peer-to-peer lending platform and achieve scale in it," says Goodall.
"By contrast, pricing is relatively attractive in buy-to-let mortgages, especially in the market for loans to professional or semi-professional landlords rather than to owner-occupiers buying a second home to provide rental income, which banks underwrite almost like a second home loan. That fits through their residential-mortgage processing machine, and Lloyds in particular has a very high market share.”
While Landbay is a disintermediation play against banks, it is competing more against wholesale-funded challenger banks, such as OneSavingsBank, Aldermore and Paragon, than against the big five UK high-street banks.
Landbay, which is regulated by the FCA but where investments are not protected by the UK’s deposit insurance scheme, promises investors compound fixed returns of 4.5% on a three-year deal or 3.35% above Libor on a floating-rate product. Those returns look lower than the headline rates on peer-to-peer platforms that match investors to consumer credit, but Goodall argues they are still good rates for much lower risk.
Landbay benefits from funding lines provided by founding shareholders that allow it to bridge interruptions between loan approvals and cash coming in from investors to match against approved loans.
“We don’t want to become a lender ourselves and we don’t have bank lines, but it is important for any platform to match that gap,” Goodall says. “For example, if we have 50 people applying for a mortgage, we might end up approving half of them. Then we can see that in eight weeks from today we are likely to have 25 mortgages of £200,000 each that meet our underwriting standards, and have to be sure we can fund them. We have less certainty as to investors’ cash coming in two months forward, so we have to ensure there’s backstop liquidity to fund our pipeline at all times.”
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The platform works closely with a number of specialist buy-to-let mortgage brokers intermediating for professional and semi-professional landlords seeking bridging loans, development loans and mortgages.
At Landbay, as at other peer-to-peer lending platforms, underwriting skills are key. Goodall says that Landbay will lend up to 80% of the value of a property only very rarely.
“The vast majority of loans are below 75% loan-to-vale with the average at around 60%, which is in line with most lenders that work at around 65% to 70% LTV. We also work on a fairly standard 125% rental income-to-debt service coverage ratio, and we’re quite focused on that income piece. Your loss-given-default isn’t going to be that much different if you are lending at 70% loan to value or at 75% loan to value. The key thing in our mind is to minimize the risk of borrowers defaulting at all, which is likely to increase if people can’t service debts out of rent. So our credit underwriting tends to focus on cash flow.”
Goodall says that the publicly available information on property values is now so comprehensive that Landbay is able to make loan decisions in principle very quickly – in as little as 48 hours, compared to three weeks at many bank lenders – though still subject to ability to claim legal title if a lender defaults and subject to surveyor’s valuation of the state of a property.
“Some borrowers need to complete quickly, and the key thing is to speed up the process for that initial loan underwriting process, even though the conveyancing process then still takes the time it takes,” he says.
Professional buy-to-let borrowers are finding their way to Landbay through the intermediation of mortgage brokers. Attracting lenders is a tough task but that is where the big opportunity is. Peer-to-peer investments are now becoming eligible for inclusion in so-called 'Innovative finance ISA' tax-wrappers designed by the UK government to encourage investment through tax relief on earned interest.
“The Ifisa may draw attention to the sector and allow it to look more mainstream than alternative,” says Goodall. “I am honestly surprised at how much retail money still sits in bank savings accounts, where it is protected but earns essentially zero. Independent financial advisers are not great advocates of peer-to-peer at the moment because they haven’t yet found a way to get paid for recommending it to customers. So our strategy for the next two or three years is to attract institutional or semi-institutional money, for example from family offices, though we want to scale up on the retail side with, for example, our Landbay property-backed ISA and our upcoming partnership with Zoopla Property Group this summer.”
In February, Zoopla Property Group, whose websites attract 10 million visits a week by people fascinated by UK property, took an equity stake in Landbay with a view to launching a strategic partnership later this year. Most of those 10 million visitors are not actually looking to buy a property, but the betting is that they may be sufficiently interested in the sector to lend against it. It will be interesting to see if Landbay, currently lending around £5 million a month, can increase lending to borrowers who have found that dream source of rental income on Zoopla.
Buy-to-let is not politically popular and has seemed to be targeted by the UK government with higher stamp duty on second homes and the removal of some tax relief on mortgage interest payments.
“I sense the government's objectives are twofold: both to ease the path for home ownership for first-time buyers and to professionalize the buy-to-let landlord sector,” says Goodall. “I have no issue with either of those objectives. If anything, these changes might make amateur landlords who haven’t done a buy-to-let think twice and perhaps boost their income instead by investing their money in secured lending to professional, incorporated landlords.”