Peer-to-peer lending sites: MSE guide discussion

rwgray

Ok, who can sum up the Thin Cats offering for us in a couple of paragraphs?

Rich.x

FatherAbraham

Looking at the MSE article (http://www.moneysavingexpert.com/savings/peer-to-peer-lending) today, it says:

The original and biggest peer-to-peer site, Zopa* lets you lend to individuals, and splits this cash up into lots of separate £10 loans, over fixed terms between two and five years. Since 2005, a quarter of a billion has been lent through it by savers.


Looking at the Zopa website (http://uk.zopa.com/borrowing/get-a-loan) today, it says:

No early repayment fees

If it's possible to repay the loan early, then it's not a fixed term.

I'm presuming that one lends at a fixed rate. Combined with the borrower having the option to repay early, that's a uneconomic combination. It's what brought the US Savings-and-Loan (building-society) industry crashing down in the 1980s.

If you lend at 7% fixed, and the borrower's credit situation improves so that he can borrow at 5%, then he is likely to repay you, closing out your position and denying you profit. All you can do is re-lend at the spot price.

If, on the other hand, the interest rate rises to 9%, you cannot renegotiate the fixed-interest offer you made, so you lose the opportunity to get the higher rate.

The borrower has an interest-rate option. It is stupid for an investor to write an option if he does not know how to price that option. Yet I see no discussion of this aspect here.

Contributors to this board (and the MSE article) seem to be focussed on the risks of capital loss (and the unpleasant interaction with the personal taxation regime). Yet this kind of loss is well-accounted for in most analyses of the returns (the only danger is that default rates rise in an unexpected way).

To put it bluntly, giving your counterparty an under-priced (or free) option is what will permit him to rip your face off, sooner or later. As Nassim Taleb says, "Option sellers ... eat like chickens and go to the bathroom like elephants". ("Fooled by Randomness: The Hidden Role of Chance in the Markets and in Life", p. 161).

Writing options is okay, if you price correctly, and can afford to pay up when your bet goes bad. However, I see no discussion at all here of the right premium to ask for, and whether one is getting it in the lending rates.

The correctly-priced option premium should at least be deducted from the returns one expects.

Why is none of the lenders here talking about it?

Warmest regards,
FA

bowlhead99

You make a great point FA.

When many lenders agree to give people money at a fixed rate, they add early redemption charges because they are tying up their funds with the expectation of banking a certin amount of profit - and so if you want to get out of your 5 year mortgage fix after 2 years you have to go some way to holding up your end of the bargain and compensate the lender with an ERC. Having no ERCs to appear borrower-friendly is part of the marketing but means the risk should be priced into the interest rate.

However, what we are dealing with here is a typical 'retail investor' - the man on the street lending through Zopa and comparing his returns to a savings account - and they are typically unsophisticated and not professional investors. No offence intended to certain individuals on here who are more savvy.

Thanks to some publicity on sites and forums like this, the typical retail punter now at least has a chance of knowing it is not like a savings account and you might lose money due to defaults: either absolutely versus amount invested, or a portion of the expected income. Armed with that knowledge he is feeling quite smug because he is one step ahead of the people who don't realise that losses can happen. So when he makes a bold claim down the pub about getting his 7%, he is prepared for some mates to say "obviously it's not at all guaranteed, right?" without that being the first time it's even crossed his mind. He can say yes it is an investment not a savings account, but I'm happy with the risk.

I would agree he probably hasn't reflected on the fact that if he is lending to people with reasonable credit ratings, and over time his rate is sitting too far above market competitors (and remembering the rate his borrower faces includes the middle-man's cut as well as the rate that he the lender is demanding), his money will just be given back to him when the borrower realises he can just go to Nationwide and takes 14,999 from them at 4.9% to pay off the Zopa loan.

Fortunately, mis-pricing that effect is not as tricky as it would have been say six years ago. Then, it was clear that a one-sided loan rate leaves the lender at a disadvantage if market rates rise, while only leaving the lender at limited upside if rates fall because the loan may simply be settled. The prevailing market rates could swing several percent one way or another and therefore that's quite a consideration when doing anything that tries to fix for 3 or 5 years.


But now, we have interest rates at all-time historic lows. Base rate of 0.5% for several years plus tons of QE is finally translating to actual market rates. With funding-for-lending in full swing, lenders are in the market with 1.5% secured mortgages (HSBC) and 4.9% unsecured (Nationwide). Presumably they will be joined by others but it does mean the risk of market lending rates dropping significantly more, has fallen, because they are already super-low. Clearly they *could* go negative but they could go a lot more positive and so one presumes we are, roughly, at one end of the sliding scale.

So, we are today in a world where there is less likelihood of someone taking out a Zopa loan in August 2013 and then in August 2015 or 2016, refinancing in a much much cheaper market and leaving the Zopa lender to find someone else to take the returned funds at a much reduced rate. It could happen but the risk is not as great as it once was.

This means that the risk of the market moving the other way (i.e. up) is the only one to be priced. The typical retail punter does not necessarily know how to 'price' this risk, in technical terms. However, he does understand in laymans terms the concept of opportunity cost and lending out your money at 5% for a long fixed term now when everyone else is able to lend at 10% in 2015.

Every mainstream bank will give you an instant access savings account and a 1-year fix and a 2-year fix and some a 5-year fix. Savers take the decision whether to lock in for longer in the hope of an improved rate. They might not understand the Black-Scholes option pricing model but they can decide if they want a higher rate and maybe not be able to access the funds for a while.

The 'risk' of early repayment is still there, but as they're (these days) relatively less likely to be frustrated by this and pushed onto a terribly lower rate when it happens(because rates are less likely to be falling) - in fact they might welcome the early return of their cash. Many savers want instant access, and resent having to lock it up - so if they do get it back early they would see it as a bonus.

I understand the point you're making, Father, but I think in the current market, the fact that it doesn't get understood by punters is less of an issue than it used to be.

easteregg_2

rwgray wrote: »

Ok, who can sum up the Thin Cats offering for us in a couple of paragraphs?

Rich.x

Secured lending with a minimum of £1000. Is that short enough ? Google Thincats review for further information.

rwgray

bowlhead99 wrote: »

I understand the point you're making, Father, but I think in the current market, the fact that it doesn't get understood by punters is less of an issue than it used to be.

I'm not sure why we even have to consider this a form of risk. If my five-year lending at 10.5% gets cashed in after 24 months then I probably ought to be mildly irritated to be having to re-lend the funds, but (a) this is a continuous process anyway, and (b) I'm always relieved when a big long-term borrower pays up before he becomes insolvent!

FatherAbraham may be a little out of his context.

For most of us small-fry retail lenders the main alternative is a boring cash ISA that pays chickenfeed at 12, 24, 36, and 60-month fixes. Yes I know there are markets open to us with fabulous yields (see above), but they require a great deal of study and usually guarantee neither the rate of return nor the return of the capital. I mean, I've invested in the theatre, myself, but i'm not dumb enough to hang my kids' future on it...

Rich.x

Saxon11

Hi could anyone help with the Borrowing bit of this scheme?
Would it work just like a bank would, who are the better sites to go with and what are the rough lending rates?

As a Lender is there more risk? what sort of securities are asked for? Are there limitations to what you could lend or are timescales less flexible?

And the biggey Peer to Pear or banks???

Ta x

Chargem

Saxon11 wrote: »

Hi could anyone help with the Borrowing bit of this scheme?
Would it work just like a bank would, who are the better sites to go with and what are the rough lending rates?

It would just be like borrowing from a bank, and most of the sites have a calculator where you can type in what you want to borrow and see what the rates are like.

As a Lender is there more risk? what sort of securities are asked for? Are there limitations to what you could lend or are timescales less flexible?

More risk than what? If you are comparing peer to peer lending with putting money in a savings account with a high street bank, then yes there is more risk with peer to peer lending.

And the biggey Peer to Pear or banks???

When people start lending money to fruit, we know it is only a matter of time before a big smoothie derivative scandal..

grey_gym_sock

Chargem wrote: »

When people start lending money to fruit, we know it is only a matter of time before a big smoothie derivative scandal..

yes, no doubt it would all go pear-shaped ...

rwgray

grey_gym_sock wrote: »

yes, no doubt it would all go pear-shaped ...

If you cherry-pick the right account, then by the applecation of compound interest, even peer-to-pear lending ... sorry, let's take a strawberry poll, are we plumming the depths of this lime of thinking already?

Rich.x

FatherAbraham

rwgray wrote: »

I'm not sure why we even have to consider this a form of risk. If my five-year lending at 10.5% gets cashed in after 24 months then I probably ought to be mildly irritated to be having to re-lend the funds, but (a) this is a continuous process anyway, and (b) I'm always relieved when a big long-term borrower pays up before he becomes insolvent!

We need to consider it, because the losses are asymmetric.

If you lend for sixty months fixed to a deposit-taking institution, you might win or might lose on interest rate movements. It's risky, but symmetric, so if you make such five-year contracts annually, you'll average out to the premium over the spot rate which is paid for the five-year contract.

If you lend for sixty months to a peer borrower who has an option to repay, then you'll tend to lose the premium when it suits the borrower to refinance (because rates have dropped), and of course you'll take a normal loss when rates rise.

In the long run, you won't get the five-year premium. Not all borrowers will realize they can use the option, as bowlhead99 points out, but some will, hurting returns.

A borrower who has the capital to hand to repay the loan is unlikely to default anyway. Early repayments are bad news.

Warmest regards,
FA