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1 Sep 2017

Is peer-to-peer lending heading for trouble?

Bad debts creep up on two of the biggest UK lenders

Two of the biggest peer-to-peer (P2P) lenders in the UK have been beset by problems over the past month, with RateSetter forced to make up a near £9m loan-deal gone sour and Zopa customers experiencing a severe cut in returns. So, is the market for peer-to-peer lending headed for trouble?

RateSetter has announced that it had to intervene to protect investors from losing money in struggling wholesale loans.

The company, which lent £664m last year, has now confirmed it has left a peer-to-peer lending trade body for breaching transparency rules. Alongside Zopa and Funding Circle, RateSetter was a founding member of the Peer-to-Peer Finance Association (P2PFA), which sets voluntary standards for the industry.

Its withdrawal brings the number of P2PFA members down to eight - Zopa, ThinCats, MarketInvoice, Lending Works, Landbay, Funding Circle, and Folk2Folk.

Find out more:Peer-to-peer lending explained

RateSetter's wholesale lending woes

P2P lending sites typically match savers with individual borrowers or small businesses. However, RateSetter came unstuck after lending investor money to another lending company - motor finance firm Vehicle Trading Group.

RateSetter lent a total of £36m to Vehicle Trading Group from 2014. This was wholesale lending, which meant that Vehicle Trading Group lent that money to other borrowers, including £12m to an advertising firm called Adpod (an unusual choice for a company that offers car loans).

Vehicle Trading Group went bust in May 2017.The Financial Conduct Authority (FCA) has warned P2P firms that lending to other lenders may be in breach of regulations.

Although it stopped writing new wholesale loans in December 2016, we asked RateSetter to explain what went wrong:

'Vehicle Trading Group originally lent its own money to AdPod. It then presented an opportunity for RateSetter to help fund this lending, with a number of risk mitigants in place, including the fact that RateSetter would have security for each loan. RateSetter agreed to this. It subsequently became clear that VTG was not monitoring the AdPod loan exposure properly and we took it on as a direct loan so that we could manage it better.'

Lack of transparency

RateSetter took over the struggling AdPod in the second half of 2016, but its customers didn't find this out until shortly after Vehicle Trading Group went bust.

The lender says it will cover Adpod's outstanding debt of £8.5m itself, rather than using the separate provision fund set up to protect against missed payments - otherwise investors on Ratesetter's investors could have potentially lost money or seen their returns falls.

It also expects Vehicle Trading Group loans to repay in full over their terms.

'Although we made a full disclosure of our interventions and acted to ensure that no customer experienced any loss, we recognise that we could have informed our customers of the intervention with AdPod Limited sooner.'

As well as winding down any new lending to wholesale lenders, RateSetter says it no longer issues business loans over £750,000.

Innovative finance Isa take-up slow

New data published by HMRC this week has revealed that take up of innovative finance Isas - accounts which allow you to invest in peer-to-peer lending tax-free - has been slow over the past year.

Just 2,000 accounts were opened in the 2016/17 tax year, with around £17m invested. An average of £8,500 has been invested into these accounts over this period.

You can find out more about innovative finances Isas in our guide.

Zopa: returns are falling

Meanwhile Zopa, another well-known P2P website and one of the 'big three' players in the market along with Ratesetter and Funding Circle, has warned investors that they may see their returns cut for products with higher projected rates of interest due to a rise in consumer debts going bad.

Recognising the way the consumer credit wind is blowing - chief product officer Andrew Lawson says the company has suspected a shift since last year - Zopa has reduced the amount it lends to higher-risk borrowers, and increased lending to those deemed less at risk of defaulting.

Because lower-risk borrowers pay lower rates of interest (whereas people making riskier loans want to be reassured by higher potential rates of return), this means that rates of return to investors are likely to sink.

Previously, investors could have their loans protected by Zopa's Safeguard feature, a cash reserve meant to cover bad debt. Under a recent restructure however, Zopa has abolished Safeguard for both of its currently available products.

Zopa says new investments will have slightly lower projected returns as a result, and existing investments will have higher losses.

Zopa currently closed to new investors

Which? has been contacted by a member who complained to Zopa after putting £1,500 into Zopa's higher-risk product, which typically projects returns of around 6% after bad debt. One year later, however, he had made only £42 - less than 3%.

In an email to the reader, Zopa said his was not an isolated case.

While it is true that investments are risky and you won't necessarily make what you hope, other more mainstream investments generally stop short of giving prospective investors predicted rates of return. Some investment funds have targets, but these are different from projections.

Zopa closed its doors to new investors earlier this year, but hopes to start accepting new people by the close of 2017.

Is P2P lending safe?

P2P lending is sometimes described as a halfway house between traditional savings accounts and the stock market - they currently offer muchbetter rates than banks, and lending can be a very stable form of investment.

You can even avoid paying tax on returns by investing within aninnovativefinance Isa, which, afterlengthy delays, is nowoffered by a wide range ofproviders.

But, like every other investment, peer-to-peer lending carries risk - namely that borrowers can't repay their loans.

Lenders can access the Financial Ombudsman Service if they have a complaint about a P2P provider. But, money isn't protected by the Financial Services Compensation Scheme should a site go bust.

The various platforms have different ways of managing this risk, for example, you might be able to spread your money across dozens of borrowers and both Zopa and RateSetter have a pot of money to cover 'bad debt' if borrowers miss payments.

However, if lots of borrowers were to default at the same time these pots could well run dry so you'll need to weigh up the risk of losing some or all of your money.

Additional reporting by Michael Trudeau, Which? investment expert