Skin in the Game

Author

Date

17th November 2016

The term ‘skin the game’ is a fairly recent addition to the P2P business lending sector’s collection of ‘cool’ phrases. An import from the equity finance side of the fence, it is meant to comfort lenders/investors with the thought that, if they lose their money, others – particularly the borrowers, but also other lenders – will lose theirs, too. But apart from sounding modern and slick, does it send a message that typical lenders necessarily want to hear? And does it have any real value anyway?

‘Skin in the game’ has crept into the picture because a few P2P lenders have taken the step of putting money from their own balance sheets into selected projects. The motive for taking this kind of risk appears to be to help certain borrowers raise the cash they need because (a) some loans do not meet the usual lending criteria and (b) in the platform’s estimation, the borrower company nevertheless deserves support. Their action bears all the hallmarks of bank lending, which is why some commentators are beginning to ask whether this is the first step towards achieving that ultimate ambition. It suggests that everyone in the P2P sector secretly wants to trade their original disrupter ticket in order to become a bank.

We can’t possibly comment on the corporate plans of our competitors, but ArchOver’s position on this is quite clear: we are not a bank and neither do we have any ambitions in that direction. We are not a venture capital company, either. We provide a matching service between borrowers and lenders, using a unique business model designed to protect the interests of all parties, but especially lenders.

Furthermore, it is our contention that having the right business model – in our case we use credit insurance to protect assets valued at 125% of the loan – offers far better lender protection than having a borrower prepared to risk their own money to the tune of, say, 5% of the total as a gesture towards the ‘skin in the game’ culture.

On the issue of fairness, surely it is far better to treat all lenders the same, irrespective of whether they are individuals, family office or small institutions; there should be no special deals for anyone. And we would also argue that it is better to conduct rigorous due diligence in the first place, and to stick to the criteria rather than try to justify special cases. We do not subscribe to the notion that borrowers and lenders want to see platforms putting their own solvency at risk through approving poor loans. That’s something the banks do!

Telegraph Hub: How P2P is Bridging the Business-Loan Gap

Author

Angus Dent

Date

4th October 2016

ArchOver has teamed up with The Telegraph to produce a series of articles to help educate investors on the UK Peer-to-Peer Lending sector. In a brave new economic and financial world, understanding different ways of managing your money is key to success. P2P Lending can help both individuals and businesses navigate a post-Brexit world, with the reassurance that it is a secured and effective method of protecting and growing your money.

As interest rates dive, new ways of raising returns on cash are sparking interest.

With the Bank Rate at a record low of 0.25 per cent and those with cash looking for reasonable returns, the peer-to-peer (P2P) lending sector is receiving a boost.

P2P lending sites offer businesses the chance to borrow money from individuals in order to expand, bypassing difficult-to-obtain high-street bank loans and replacing inflexible and sometimes pernicious invoice discounting facilities.

Some lenders receive returns in excess of 7 per cent on P2P lending sites, but risk losing their cash if the business goes under. This is the issue that Angus Dent, chief executive of P2P platform ArchOver, believes he has addressed with a unique form of security for lenders.

Mr Dent, a chartered accountant and technology business expert, founded ArchOver after realising there was a gap in the market for medium-sized loans for growing businesses.

“If you needed a £50,000 overdraft you could probably get it from your bank and, if you needed more than £3m, you could approach a venture capitalist,” he says. “But there wasn’t any reasonable way you could raise, say, £500,000 or so for your business.

“We also saw there were an awful lot of people who had money on deposit that wasn’t doing very much. ArchOver aims to put those people together in a way that is rewarding for everyone. The name refers to our platform, which arches over from the people with cash to those who want to borrow.”

Loans made through the ArchOver platform are “secured and insured”, which Mr Dent says provides “unparalleled investor protection”. The security policy involves insuring each borrower’s accounts receivables – the money owed by their customers for goods and services that have already been delivered – against the loan.

The main reason why company borrowers don’t repay loans is because their customers don’t pay them. Credit insurance successfully mitigates this risk. Given that most of the borrowers take credit insurance from Coface – an A- credit-rated supplier with a very good record of meeting claims, which represents a significant safeguard for lenders.

Different types of lending provide different types of security, and different types of security offer different levels of liquidity. By securing loans on Accounts Receivable he believes the security is relatively easy to value and liquidate, meaning that the likelihood of getting your money back in the event of a disaster is high. This compares well with property, which is often held up to provide great security, but which is difficult to value and often illiquid. That said, lending should only form part of a diversified portfolio of investments. “We believe people are grown-ups and should do their homework on their investments,” he adds.

The minimum that an ArchOver user can lend to any one borrower is £1,000, an amount that he believes means people will carry out the correct amount of research. “Most people will take an investment of £1,000 seriously,” he says, suggesting ArchOver is suitable for those with a portfolio of different investments, including those people who are managing their retirement income. “Our oldest lender is 89,” he confides.

Lenders are encouraged to find out more about the company that they will be lending to, including the reason for borrowing the cash.

Some of the businesses that have borrowed from ArchOver have included timber frame restoration specialist TRC, healthcare service provider Spirit Healthcare and accountancy business Spain Brothers. In each case, the company found ArchOver offered a better service, a combination of lower price, much lighter touch processing and no personal guarantees than they could get from a bank or invoice discounter.

So far ArchOver has facilitated £22m of loans with no defaults or losses, and Mr Dent believes the uncertainties created by the Brexit vote could further increase demand for the product. “While some businesses will decide not to expand, others will need to find growth finance and, with interest rates at 0.25 per cent, there is more demand than ever from those with cash who are looking for new ways to make their money work for them.”

Falling Further Down the Rabbit Hole

Author

Angus Dent

Date

3rd August 2016

The rate at which the Bank of England is prepared to lend short-term money to financial institutions looks set to fall below its current historic low of 0.5 per cent to 0.25 per cent, a move designed to stimulate the stuttering British economy. However, I would argue that further suppressing the cost of credit will do little to help British businesses battling Brexit uncertainty. Instead this rather negligible Interest Rate reduction will inflate the debt bubble while further punishing pensioners and savers, thereby diminishing waning economic confidence; thus costing companies dear. So what is the MPC’s rationale?

In Money Creation in The Modern Economy – a paper published by the Bank of England in 2014 – Michael McLeay, Amar Radia and Ryland Thomas explain how commercial banks create money via the provision of loans to households and companies. Contrary to economic theory outlined in most textbooks, ‘rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits’ (McLeay et al., p.1, 2014). It is thus the commercial banks (not the Bank of England) who create money. The interest rate – otherwise known as the ‘repo rate’ – acts as the ultimate constraint to commercial bank’s ability to create money as it determines the price and consequently the profitability of lending. By lowering interest rates, the MPC are reducing the price of credit and thus imploring commercial banks to conjure up more money by writing new loans.

The MPC hope that more ‘fountain pen money’ – money created at the stroke of bankers’ pens – might help to sand over the cracks our decision to leave the EU has created. It will not. Rather, it is a vote of no confidence in the UK economy, an economy currently plagued by uncertainty. What’s more, it proves we have learnt little from the 2008 financial crisis. As Mervyn King (2010) suggests, ‘for all the clever innovation in the financial system, its Achilles heel was, and remains, simply the extraordinary – indeed absurd – levels of leverage represented by a heavy reliance on short-term debt.’ Would raising interest rates be such a bad idea?

Product or Service?

Author

Angus Dent

Date

29th July 2016

The CEO of the FCA, Andrew Bailey’s, comments to the House of Commons’ Treasury Committee when questioned by Chris Philp MP, have given rise to some comment and a very good open letter from Christine Farnish, Independent Chair of the Peer-to-Peer Finance Association. The discussion so far is one of detail. It seems to me that before we get to the detail we should consider the principles involved.

Usually banks, correctly in my opinion, describe what they provide as products. We as consumers buy a product, say a deposit account paying 0.5% interest pa. We have no idea what the bank does with the money, that’s not our concern; we have our 0.5% return. Which given the doctrine of ‘too big to fail’ is correctly almost the risk free rate of return……a few Italian readers may disagree. No further information is required.

On the other hand P2P lenders provide a service to their lenders (and borrowers). We bring the opportunity for lenders to earn a on their money than is available with a bank product. We should make it clear how much security the lender will have and leave it to the lender to make a judgement on whether or not the trade off between security and return suits them.

Of course this begs the question how much is sufficient service; another judgement call. Most of the platforms will, correctly in my view, provide credit analysis on the potential borrower. It is for the lender to assess whether the platform’s systems of credit analysis are sufficient for their purposes. The platforms must, and do, publish their systems of credit analysis. Too few, again my judgement, of the platforms provide a sufficient monitoring service after the loans have been made (perhaps this is driven by the upfront fee model, as Chris Philp suggests). The platforms should provide sufficient information on the potential borrower, or class of borrower, to allow the lender to make a judgement on whether to lend. To my knowledge all of the platforms work hard at this provision and are regularly increasing the amount and scope of the information provided. Regretfully, as with all markets, there will never be a perfect provision of information.

It is for the potential lender to judge whether the information provided is sufficient. If they don’t find it sufficient then they’ll leave their money with the banks product. The decision is always with the lender. After all it is the lenders capital that is at risk, this must always be made clear.

Accepting the principal that the banks provide a product and the P2P lenders a service is the first step in accepting that the P2P lenders need only a small amount of capital, when compared to a bank. The capital required by the P2P is sufficient to allow the P2P, in a calamitous financial position, to transfer information under its living will to another nominated party to monitor all loans facilitated to repayment. This is, of course, exactly what the FCA require of us.