Rate trends in a maturing P2P market 21/12/2016
From our analysis of the market we anticipate lower average loan rates, along with an increase in loan quality.
These linked trends are a confluence of events in the wider alternative finance SME loan market – indeed, debt markets generally – and ThinCats’ own due diligence.
The new ‘new normal’
This isn’t a new trend in alternative finance, but it is feeding through. Private debt market yields have been slowly declining from their peaks at around 2010 or ’11. The dynamic isn’t difficult to understand: prior to the global financial crisis, European banks, including those in the UK, dominated business lending, with about 90% market share. In the credit crunch that accompanied the crisis, banks stopped lending. Companies still needed cash, and so while demand stayed strong, supply had collapsed. Enterprising investors, from private debt funds to ourselves, noticed this gap and entered the market.
It was initially like filling a bath with a thimble. However, rates came down earlier in some areas of the market, particularly with larger and more ‘plain vanilla’ loans, as banks, having detoxified their back books, decided they would come back into the game – albeit on a much more limited basis than previously.
We have been deliberately lending in an area of the market that is less attractive to the increasingly box-ticking driven approach of the banks. However, we are not immune to the general trend, and competition is increasing, so depressing rates.
One further factor should lower average rates on the ThinCats platform over time, and that is the overall quality of deals that we attract. Our Credit Team has been carrying out due diligence on loans for about a year, and believe that this adds an important layer of security for our lenders. We put considerable resource into determining a company’s ability to service its debts – something that had historically been the responsibility of the Sponsors. Credit markets being (relatively) efficient, one would expect this to positively affect the default rate, thus helping shield lenders from loses that an absence of checks could bring.
The corollary of this is that higher quality loans be less risky and so pay lower rates. Higher risk correlates to higher rates, which is what you might see in, for instance, credit markets: high-yield bonds pay a higher coupon than investment grade bonds because of the higher implied risk; investment grade bonds pay higher rates than government for the same reason.
So, while the enhanced returns generated by extraordinary market conditions look like they are tapering out, the positive news is that quality control operated by ThinCats should facilitate more stable returns to our lenders, provided by transparently-priced quality loans.