AltFi Insights: Funding Circle has sneezed, will the alternative lending industry catch a cold?

Investors wait to see if reduced growth and paused expansion at market leader Funding Circle will feed through to the rest of the industry.

Funding Circle cut its revenue growth forecast in half this year to 20 per cent due to "uncertain economic environment", but is this news from the country’s largest peer-to-peer lender a further sign of a slowing economy?

"The uncertain economic environment has reduced demand from small businesses and led us to proactively tighten lending criteria,” said the firm’s co-founder and chief executive Samir Desai in a half-year trading update last week.

The FTSE 250 group also “paused” plans to expand into Canada, its share price fell to a new low of 116p last Tuesday, a far cry from its float price of 440p last October.

The Bank of England’s nine-member monetary policy committee (MPC) last month slashed its growth forecast for the three months to June to zero, from 0.2 per cent, citing global trade tensions and the increased likelihood of a no-deal Brexit.

Testing times

“Underlying growth in the UK appears to have weakened slightly in the first half of the year relative to 2018,” the MPC said.

Firms in the alternative credit industry look to be heading into a period where their business cases will be fully tested.

These lenders were formed in the aftermath of the 2008 financial crisis, when small firms searched for new forms of lending, after banks curtailed these types of loans, fearing defaults.

As the country struggles through a period of low growth alternative credit providers - from peer-to-peer lenders such as Ratesetter or invoice lenders like MarketInvoice - will be forced to show they can still write profitable loans. They will have to prove they will not be swept away by a downturn, which a decade ago sparked their inception.

Avoiding finance

Lenders approved over 290,000 loans and overdrafts to small and medium-sized enterprises last year worth £28 billion, according to UK Finance. But this is a small amount compared to the 5.6 million small firms that employ 16.3 million workers in Britain.

Apart from a slowing economy, alternative lenders also have to fight against a reluctance by small firms to use outside finance at all.

“Most SMEs are willing to forgo some growth in order to avoid finance, and even those that already use external finance have often not thought about using more,” according to a British Business Bank report, Small Business Finance Markets 2018/19.

It adds: “The outcome of this reluctance to use finance is that the number of SMEs seeking new finance has weakened further”

Trouble ahead

However, Growth Street, which last week announced that it had originated more than £500m of loans since the business lending platform was launched five years ago, said the pipeline of loan applications it was seeing from small businesses was still strong.

Growth Street advances loans similar to overdrafts to small firms, who typically are around six years old, and range across the economy from construction to services. Its loans account for around one per cent of the UK’s overdraft business lending market. 

But co-founder and chief executive Greg Carter does see signs of trouble ahead.

He said: “Recent manufacturing, construction and services data suggests the economy is starting to struggle. There was quite a bit of unproductive investment in the first quarter of the year, as firms stockpiled because they thought Britain would leave the European Union on March 29. We may see that again in the fourth quarter, in the run up to the October 31 deadline. But this kind of investment does not lead to growth, and is very frustrating for businesses.”

Acid test

However, Carter accepts that a downturn will be the “acid test” for alternative lenders.

“We will have to nimble, but at the same time not change our lending criteria. That may mean we may get many more applications that we can’t approve. But the acid test will be to make it through a downturn with our business still intact.”

The industry will wait to see if slashed growth targets and a greatly reduced share price at Funding Circle heralds the beginning of alternative credit’s acid test.