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WeB@ank - Zopa and Social Lending Thursday, January 22, 2009

One of the 3 firms showcased at the WeB@nk event this week that was hosted by Nesta was Zopa. Nearly 4 years old, Zopa [which stands for "Zone of Possible Agreement"] describes itself as a market for money. Targeted at the retail market, the platform has executed £31m of unsecured loans to date across over 7000 loans, with £12.6m booked in 2008 for 2600 loans. Their maximum loan limit is £15k and typical loans have been for cars, weddings and medical expenses - the loan purpose has to be detailed as part of the information provider by a borrower.

In supplying offers of cash, lenders specify

the total amount on offer up to a maximum of £25,000 beyond which a lender needs a Consumer Credit Licence
the rate they are prepared to lend at, which can be set per borrower risk category
the maximum amount per borrower they are willing to commit e.g. no more than £100 per borrower [Zopa sets a floor of £10 minimum per borrower]
the loan term
the category of risk they want to invest in [Zopa stratifies its' borrowers across 5 risk categories]

Borrowers

Complete a loan application
Make monthly repayments comprising capital and interest
Can borrow over 36 or 60 months with the ability to repay early
Pay a loan fee of £94.25 when taking a loan
Can borrow between £1,000 and £15,000

Zopa's role is to

provide the marketplace platform
pool funds provided by lenders and distribute these amongst eligible borrowers
vet lenders and borrowers against anti-money laundering criterion
credit score borrowers
undertake loan administration i.e. cash distribution and collection, oversee debt recovery via a third party arrangement

Apparently Zopa's average lender is male, 40 years old, living in SW London who lends £1300 whilst their average borrower is male, 40 years old in Birmingham and borrows £4300 for a car.

Zopa were at pains to stress that many people are attracted to Zopa because it puts a human face on money which they termed "Social lending", rather than the impersonal and institutionalised banking that traditionally operates. Yet as one member of the audience put it, "they made it sound like charitable work or lending for emotional/entertainment value".

Zopa did acknowledge that the flip side to social lending is that it can turn sour/personal when bad debts arise as people feel their "trust" has been betrayed. Overall Zopa has experienced 0.2% bad debts to date, and provides its' lenders with an estimate of bad debts per risk category as shown here.

One of the major selling points of Zopa is that borrowers and lenders reportedly get better rates than from banks by interacting directly. Lenders are presently getting an average of 8% after fees compared to high street savings ates of under 2%, whilst borrowers are receiving loans at 9% compared to 15%+ from a bank from unsecured loans.

I felt quite strongly that Zopa is disingenuous in making interest rates comparisons between themselves and banks for savers. When depositing with a bank you are transferring loan default risk to them and losses are borne by the bank's shareholders. Depositors also benefit from deposit protection schemes in the event of bank default. In Zopa you retain this risk. Hence an element of the rate differential has to compensate for that. In conversation after the event, their MD admitted to me that whilst the rate differential is about 6% following the sharp fall in bank deposit rates [Zopa lenders are averaging 9% less 1% Zopa fee versus average savings rates of 2%], back in the summer it was about a 2% differential.

What astounds me about this latter figure is that it indicates that Zopa lenders are clearly not making an allowance for borrower default. Whilst average historic loss rates may be only 0.2% across all lenders, those lenders who lent to defaulting borrowers will have been lost much more. More significantly, whilst Zopa claim that their credit screening process rejects a considerable percentage of borrower applicants and keeps them clear of sub-prime loans, I suspect that the deterioration in the economy is going to push up their default rates in line with the experiences of banks on similar tranches of unsecured personal debt.

My assertion regarding default risk being overlooked by lenders was further validated when I enquired about whether Zopa would consider offering credit protection insurance and Giles advised that it had been offered but there had been minimal interest in the product. Perhaps people are being overly seduced by the touchy-feely aspect of "social lending" and become too trusting or are ignorant of the risks.

Whilst savers are undoubtedly complaining about the pitiful rates currently offered on deposits, in the current environment I suspect that many people are most concerned about return of capital than return on capital, at least temporarily.

As James Gardner of Lloyds TSB (Bankervision) put it during the panel session, the real question is whether Zopa and its' kind represent a significant threat to banking and could disrupt the current model. He contended it did not and I have to concur. Whilst I believe Zopa has considerable growth potential from its' current low base and is not liable for losses on loans, I'm not convinced about its' business because

despite having increased it's margin from 0.5% to 1%, this feels like insufficient gross margin on which to operate and develop the business. For example, at best Zopa is generating approximately £300,000 of interest revenue each year on £31m of loans, assuming all loans transacted on the platform were open, no capital repayments had been made and 1% was applicable to all of them. On top of this, Zopa will have generated just under £200,000 of borrower loan fees in 2008. Once costs are factored in e.g. staff, premises, insurances and technology, this doesn't leave much.
Zopa isn't a regulated business at present, but were it to scale-up I believe that regulators would probably be forced to take a closer look. As James Gardner observes, were a major bank to enter the peer-to-peer lending space it would be inevitable that regulators would seek to include it as a regulated activity. At this point, its cost of operation would increase considerably putting further pressure on its' margins.
Zopa claims that all elligible borrower applications have been funded to date, demonstrating that their supply of funds is sufficient. However this is represents a probable and material constraint on their business. The higher rates currently on offer may induce more savers to use the service but I believe that Zopa will also need to increase the average deposit several fold from the current average of £1,300, which translates into an average of 3 savers per borrower. Whilst banks have a similar situation, they can also supplement funds from wholesale markets, leverage and shareholders. None of these options are available in Zopa's current "peer to peer" model.
Banks have considerably more experience in loan pricing than individuals and I question whether the rates presently on offer on Zopa may represent naive pricing on the part of lenders once bad debts/risk premium is taken into account. Obviously I acknowledge that bank lending rates will be higher simply to allow for bank profit and bad debt provisions, but stripping out such elements are likely to suggest higher rates should apply.

All that aside, I am a huge fan of such electronic markets and respect the ingenuity that has gone into Zopa. It is logical, will make a difference to its' users, and has a strong and easily understood sales message. Moreover, I recognise that that the supposided dramatic contraction in personal loan availability from the banking sector and collapse in savings rates will drive Zopa's borrower and lender numbers up [influx of former Icesave customers perhaps]. Hence, in this "perfect storm" I shall not be surprised if its' MD is able to report a doubling or trebling in business by next year, but disappointingly this will still leave it with a loan book of less than £100m.

Labels: banks, Financial services, James Gardner, Lloyds TSB, Loan, markets, Peer-to-peer, Zopa

posted by John Wilson @ 3:50 PM Permanent Link ,

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WeB@ank - the case for peer to peer lending

The 150 or so people attended the Nesta run "WeB@ank" event last night on the subject of peer to peer finance models and businesses were treated to a lively and polarised panel debate involving Giles Andrews (MD, Zopa UK), James Gardner (Bankervision and LloydsTSB) and Umair Haque (Havas Media Lab).

Unfortunately Umair's contribution lacked any real relevance to the discussion and left him appearing as someone wanted to be a deep-thinking academic offering higher plane wisdom and insight, but who actually came across as someone out-of-touch with matters at hand. Of course, he may retort that I was simply not bright enough to understand his mutterings but it was evident I wasn't alone in my thinking speaking to others in the audience later.

Fortunately, James and Giles were excellent sparring partners on opposite sides of the debate. Indeed, it almost had a pantomime feel to it with the traditional banker ["the baddy"] questioning the upstart model ["the goody"] - Giles was even pulling exagerated faces to win over the audience when James was speaking.

Good contributions came from the audience, which further the discussion. Disappointingly, though Nesta's organiser decided to cut the debate short simply to fit into the closing time they had publish which sadly failed to reflect the momentum the evening had built up.

Congratulations to Nesta and Christian Alhert at Open Business for organising the event.

I intend to post separately about the presentations from three firms who were showcased, namely
- Zopa, a loans marketplace
- Kubera Money
- Midpoint

Labels: banks, Giles Andrews, James Gardner, Lloyds TSB, Nesta, Open Business, Peer-to-peer, Umair Haque, Webank, Zopa

posted by John Wilson @ 12:26 PM Permanent Link ,

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Are Banks commiting to unwise lending practices? Monday, October 13, 2008

RBS, LloydsTSB and HBOS have all committed to maintain the availability of SME and mortgage lending at least at 2007 levels as part of the Government share scheme, agreed over the weekend.

This implies a considerable expansion of lending over current levels, which has to be considered precarious entering a recession. Whilst lending criteria might be tightened i.e. Loan to Value ratio is going to be less than 95% etc, it is hardly going to improve the bad debt prospects for the banks. Moreover given that this is now an explicit lending target, lending policies and rates will have to be adjusted to ensure it is met.

Obviously the Government is keen to ensure that the economy remains primed with access to credit but does LloydsTSB+HBOS really need to add to its' existing property market exposure. It may be politically expedient, but is it really good for new shareholders i.e. Us.

Labels: HBOS, Lloyds TSB, mortgages, RBS

posted by John Wilson @ 9:38 AM Permanent Link ,

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HM Treasury get Buffett-style terms from the Banks

Extract from LloydsTSB regulatory news announcement this morning

HM Treasury will subscribe for £1.0 billion of Lloyds TSB preference shares. The preference shares will carry an annual coupon of 12% (non tax deductible), and will be callable after a period of five years.

Under the terms of the preference shares, the enlarged Group will be precluded from paying a cash dividend on its ordinary shares whilst any of the preference shares remain outstanding.

Not cheap financing for a Group that only two weeks ago was insisting it was in decent shape.

Labels: credit crunch, HBOS, Lloyds TSB, Market turmoil

posted by John Wilson @ 9:30 AM Permanent Link ,

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HBOS and the Deposit Protection Scheme Thursday, September 18, 2008

Image via WikipediaSadly I am marked out in our family social circles [school parents and friends etc] as someone who allegedly knows about technology matters [translation - "you can fix my computer/printer/network"], and similarly knows about Finance. Consequently, the last few days have invariably involved answering questions about a) what's going on in the City and share prices and b) is my money safe with XXXXX.

Listening to people, common misconceptions and superficial knowledge abounds, much of which has been recycled from the "popular" press e.g. the evils of short sellers, the fault of the banks in giving too much credit [setting aside that many people benefited from loose credit in the economy], derivatives being the cause [ask people what they are referring to or to define them and the conversation stops], speculators / hedge funds being villians.

I confess that I have greatest difficulty answering b), partly because the repercusions of a wrong answer are immense. Hence, I've tended to limit my answer to "Go to a big institution - the bigger the better for now". HSBC, Barclays Bank, RBS and LloydsTSB probably count as too big to fail, but it's getting harder to make that call. I've supplemented this with the guidance that diversifying deposits between institutions is wise, and if you are particularly concerned then have regard for the amount covered under the Deposit Protection Scheme in the UK.

The Scheme covers up to a limit of £35,000 per customer for the total of their deposits with an organisation, regardless of how many accounts they hold or whether they are a single or joint account holder [a joint account for 2 people counts as 2 customers in this regard]. The scheme also nets off deposits against any loan balances i.e. any monies owed on a mortgage or overdraft will be offset against any deposits and the net amount covered under the scheme.

However, the sting in the scheme covers the word "organisation". Different banking groups operate slightly different structures. In the case of RBS, which also owns the NatWest brand, these legally operate as distinct organisations for the purposes of the scheme. However, Halifax, Bank of Scotland and Birmingham Midshires, which are all part of the HBOS Group, only count as one organisation [Bank of Scotland plc] - all the brand names are Divisions of the same organisation.

This subtle distinction is not obvious to the "man in the street" and if you asked customers of these Divisions who their deposits were with placed with, I am confident that a sizeable majority would answer with the brand name. By extension of this, it is likely that by virtue of historical arrangements or ignorance, some customers will indeed have separate relationships with different parts of the HBOS without realising they are dealing with the same entity.

Importantly, you couldn't blame them for such an error. Inspecting several of the websites of the HBOS group that accept deposits, only Birmingham Midshires makes clear on its' home page that it is a Division of Bank of Scotland plc. In contrast, no reference is made to this on the Halifax home page, despite its' significance - you have to check the Contact Us section in one of the footer links to find this.

To their credit, the BBC have been reporting this issue for several months, including today.

Labels: Bank of Scotland, Birmingham Midshires, Deposit Protection Scheme, Halifax, HBOS, Lloyds TSB

posted by John Wilson @ 8:19 PM Permanent Link ,

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Black Horse gallops to Howard's rescue

After months of torture, under continual share price pressure and doubts about its' liquidity, HBOS has finally capitulated and agreed to a friendly take-over by Lloyds TSB. The speed of the deal has shocked many, but it was essential - already the "man on the street" had begun to read worrying stories about HBOS, with the next step being to withdraw their money, thereby kicking off a run on the Bank.

The Govt has already confirmed this morning that it will set aside competition rules to allow the deal to go through - the combined entity will control a third of the retail banking market [deposits and mortgages]. It will also begin with 140,000 staff, but inevitably there will be a large shake-out of staff as duplicate functions are removed. Obvious examples

branch network overlaps
Head office functions e.g. HR, Finance, Treasury
back office functions e.g. mortgage and cheque processing

It looks likely that the HBOS name will disappear and the combined entity will trade as LloydsTSB. Some of the brand names will be preserved but others will fall by the wayside once the "brand consultants" have performed their comparisons e.g. Scottish Widows v Clerical Medical, Halifax v Cheltenham & Gloucester.

There will also be businesses to be merged and already their CEOs will be wondering whether they will have a role going forward. An obvious example is the asset management businesses of the banks, namely Insight Investment [HBOS, £112bn assets under management] and Scottish Widows Investment Partnership [LloydsTSB, £90.2bn assets under management]. Whilst integrating these two firms is likely to take over 12 months, a combined management structure will be announced quickly if standard practice is followed. Following this, organisation charts will be fleshed out, respective counterparts met and plans will be drawn up to integrate including choices made over

systems to be used
building and locations
suppliers

The ramifications will continue long after this banking deal has been done. Anticipated annual savings of £1bn has been announced with the deal - that means people and infrastructure to be culled.

On an optimistic note, one can only hope that the annoying advert featuring the "surfing" staff member will be canned as a result of this merger.