Bonds vs Peer-to-Peer Lending
Bonds and Peer-to-Peer (P2P) loans are both fundamentally debt instruments. They both produce similar returns and offer investors, in the current long term low interest rate environment, with much needed regular fixed income.
It’s impossible to make a direct comparison as there are different types of bonds and there are different types of P2P Loans but we should be able to agree that they are both debt instruments, both offer similar returns and both should be part of a balanced investor portfolio.
Bonds are loans from investors to governments or companies and generally produce a fixed income return over a set term, at which point the bond is repaid and the capital investment returned to the investor. Bond rates of return vary depending on who issues the bond, if it is listed, if it is rated, the term of the bond, and the perception of risk that the government or the company who issued the bonds ability to keep up the repayment schedule and then repay the bond. Bond returns can range from close to zero (in fact earlier this year some companies bond yields went negative) up to double-digit returns for what could be termed ‘junk status’.
This fixed income financial instrument shows very similar characteristics to a P2P loan, especially one made as a property backed P2P loan, where loans are made on an interest only basis with a bullet payment at the end of term. At present, Property backed P2P loans offer returns of between 5-12% pa*, with rates vary depending on the borrower, the property and the strength of the tenants.
Investing in either comes down to risk and liquidity:
- How much risk am I taking by investing in this Bond or P2P loan, will the borrower make the interest payments, and will they redeem the investment? One way to reduce risk is to ensure that there is some collateral the borrower has pledged against the loan. If the borrower defaults on the loan, the collateral can be sold in order to make payments against the outstanding loan. One of the best forms of collateral is property because it’s a hard asset and can be valued. There is a long -established process in order to take security against property, and it can be sold relatively easily.
- If a bond is listed, this increases its liquidity, making it easier for a current bond holder to sell before the bond was due to be redeemed. If there is no or minimal liquidity, then the borrower effectively pays an illiquidity premium to the investor.
Let’s try and make a comparison between a P2P Property Loan and a Property Company Bond
P2P Property Loan
Proplend, for example, would offer investors the opportunity to invest in a P2P loan via their platform. The investors are investing in loans between themselves and the borrower. The tenant in the property pays the borrower rent and the borrower pays the investors’ monthly interest or income. As collateral to support the investment, the borrower has offered the investors a first legal charge over the property. Should for whatever reason the borrower default on the loan, the property can be sold, and the P2P investors are first in line to receive payment from that sale. Lending with the security of a first charge is the least risky position in the capital structure. P2P loans are not listed, so unless the P2P platform has its own secondary market that is very liquid, the investor will require some liquidity premium from the borrower. As a generalisation, P2P property platforms offer investors returns ranging from 5-12% pa* and the loans will be secured against a variety of property types depending on the specific platform, Commercial Investment, Residential BTL, Refurbishments or Developments.
Returns: 5-12% pa*
Interest paid: monthly
LTV: below 75% (although Proplend offers investors the ability to limit their capital exposure through our tranching model)
Security: 1st legal charge over the property
A well-known property company recently issued a seven year retail bond paying 6% a year. Interest is paid twice a year to investors. The company has guaranteed as a condition, that throughout the life of the bond, the company’s net debt will not exceed 75% of its property portfolio. If you look at the capital structure of that company, the banks who have lent the debt against the properties in the portfolio and who hold a first legal charge will be the first to be repaid. Once the debt has been paid then the Bondholders are paid and after that the equity / shareholders. So there is liquidity in this bond, there are properties that offer some form of security but the bondholders don’t have the first legal charge against those properties. They are not the first to be paid when the properties are sold, but they do sit ahead of the equity.
Returns: 6% pa
Interest paid: twice a year
Liquidity: high as listed
LTV: greater than 75%
Security: Backed by property portfolio but sits behind bank debt who hold the first legal charge
You can draw clear comparisons between the two instruments which both offer similar returns but potentially not similar risk adjusted returns. For the savvy investor, it should not be a case of one or the other but a potentially a bit of both. Investors will ultimately decide which route offers the best risk adjusted returns but we think that over the next 12 months, the P2P market could take a significant market share.
*After fees, but before bad debts and taxes