Alternative Lending and Securing Yield

By Richard Whitehouse, Sales Director, Sancus Funding, The Sancus Group.

Alternative Lending, which comes under the umbrella of "Altfi", has grown rapidly since the Global Financial Crash of 2008, filling a gap left by Banks forced to retreat from the SME lending landscape. The deployment of Altfi is now estimated to be worth in excess of £6.2bn*. With Altfi models relying on 3^rd party capital to power their loan books, this represents a considerable opportunity for the Private Wealth community to deploy capital and earn yield.

There have been some recent high profile failures in the Altfi space which has shaken confidence in the sector and it is important to fully understand what happened in these instances.

What can the private wealth industry learn from the collapse of platforms like Lendy and Collateral when selecting platforms in which to deploy capital?

Altfi is relatively new but lending is not, understanding the experience levels of the team, particularly those involved in proposing, decisioning or managing credit within the lender is, unsurprisingly, crucial. Far better for a large, high street bank to have paid for the training and mistakes of your chosen asset manager than that company "learning" on your tab.

In addition to the platform's employed experience, an understanding of the advisors the platform calls on in the due diligence (DD) process matters. Does the platform run a Valuer panel and what are the criteria for selection? Alternatively, do they use a valuer validation service? It's rarely a good idea to use a valuer in Carlisle to provide a valuation on a property in Canterbury, no disrespect intended to the professional community of Carlisle! Are the chosen lawyers experienced in the asset type under consideration and how is this assessed? As Jonathan Newman of Brightstone Law wrote in the Bridging Loan Directory those advisers should be able to demonstrate "…service excellence, broad market range experience and long term responsibilities (to the platform)…". Any platform you choose to engage with should be able to articulate how their advisors live up to those 3 tests.

Diversification is a commonly used investment strategy but in relation to platform selection there are two further areas in which diversification is important; Income and Capital.

Platforms that lack diversity in their income base will either be operating under false incentives or vulnerable to market changes. For example, a platform whose income is entirely reliant on arrangement fees will focus on generating new loans potentially to the detriment of the credit decisioning. Income profile should be consistent with the platform's expenses, so a platform reward structure that provides trail income to cover the operational expenses of managing the loan book matters. Whilst that might sound troublingly obvious, it hasn't been and isn't always the case. Equally, if the only source of income is from upfront fees then a slowdown in completion timeframes for example will put significant pressure on cashflow. In Lendy's case over 75% of the loan book by value was development finance. When those loans came under pressure so did Lendy's revenue lines and ultimately its ability to trade.

Understanding the platform's capital base is also a good guide. How broad and reliable are the capital pools of your chosen platform(s)? Those that rely on a single pool and / or lack diversity within the pool will be vulnerable to changes in sentiment or policy. Once Lendy lost the confidence of the crowd, funding loans became almost impossible.

Platforms with an element of institutional capital will be subject to at least one other form of DD and will probably be well beyond the level of comfort approval by the FCA would provide. That should help give more confidence that the platform is robust. Lenders that can lend alongside you with their own capital also have a far greater alignment of interests than those who rely entirely on 3^rd party funds.

Access to a variety of capital pools also gives confidence that the forward loan book is underwritten. This is especially important if you are deploying capital into property development loans, where you, as a funder, are reliant on all the future drawdown requests being met. Some of the problems experienced by Lendy's funding crowd are a direct result of them deploying into early tranches on development loans and the project failing because later drawdown requests could not be honoured by Lendy.

Finally, the default rate at Lendy was beyond anything reported or encountered by other lenders in the sector. Lendy appear to be the outlier not the proverbial "canary in the mine".

*Cambridge Centre for Alternative Finance 2018