Why I’d Sell Wellesley Loans

Neil Faulkner says that with low interest rates for lenders, less impressive loan book performance than similar competitors, increased risks from borrowing to lend and not enough of the right kinds of unambiguous information and data, he sets out his opinion that, if he was lending through Wellesley, he would sell Wellesley & Co.’s P2P loans until its future is more clear – will it bounce back!

When 4thWay launched in 2014, I wrote 10 basic lending principles that lenders should always follow (recently re-written to empty it of my poor grammar by Matt, here). I believe these principles remain true today. I thought of at least five of those principles when writing this report:

Principle One: Only lend when you are supremely confident you understand all the risks.
Principle Two: Only lend when you are getting a decent premium over savings accounts and cash ISAs.
Principle Three: Treat buried information as if there's a reason, missing or ambiguous information as if it contains bad news, and decreased information as if it contains worse news.
Principle Eight: Return of capital (the money you lend) is more important than return on capital (the interest and profits you earn when lending).
Principle Nine. Don't borrow to lend. There might be rare exceptions to this principle, but they will be truly rare.

What I’d do right now

Now, Wellesley* has completed over £360 million in loans since 2013 and no lender has ever lost any money lending through Wellesley. Wellesley itself has covered all losses out of its own pocket, and its lending products are simple to use. (Read A Brief Background On Wellesley.)

I’ve also met some great people at Wellesley but, if I was lending through Wellesley, l would try to sell my loans early, for the time being, until I could get better rates and a lot more clarity, which I think might take at least 12 months.

Below is the factual basis for that view as far as I can see and interpret the facts. It’s the cumulation of all the below that makes it a sell to me, as opposed to a single major factor.

While I am expressing my own opinions, I have incorporated additional 4thWay research from one of my colleagues, experienced fund manager Melwin Mehta.

Please note this article is focusing on P2P lending through Wellesley only, which excludes Wellesley’s bond products which are loans to Wellesley itself.

Interest rates on Wellesley’s P2P loans

If you lend new money today, or re-lend interest received from pre-existing Wellesley products, you get these rates:

Wellesley 2-year rate	2.32% fixed (compounded)
Top 2-year savings account, OakNorth Bank Top well-known 2-year savings account, Tesco Bank	1.56% fixed 1.52% fixed
Top 2-year cash ISA, Aldermore Top well-known 2-year cash ISA, Virgin Money	1.25% fixed 1.15% fixed

 

Wellesley 1-year rate	2.25% fixed
Top 1-year savings account, Ikano Bank Top well-known 1-year savings account, Tesco Bank	1.4% fixed 1.26% fixed
Top 1-year cash ISA, Al Rayan Bank Top well-known 1-year cash ISA, Virgin Money	1.09% fixed 1% fixed

 

From the above tables, you can see that Wellesley’s premium over the top two-year savings accounts has fallen to a negligible 0.76 percentage points. Versus the top two-year cash ISA it is a similarly paltry 1.07 percentage points.

Its premium over the top one-year accounts are only marginally better.

Considering the government guarantees up to £75,000 of bank deposits, per person, per bank (or sometimes per banking group) the risk of sudden large losses in savings accounts are clearly minimal.

Before you say it – not everyone doing P2P lending through Wellesley is earning those lowest rates yet, because they have locked in higher rates for a while in older Wellesley lending products.

Yet the remaining points in this article, focused on the risks, still apply. Sorry for its length and complexity but there's a lot I wanted to write about.

Assessing the risk of losses from bad debts

Read about The 13 Key Peer-To-Peer Lending Risks Risks for a brief summary of this risk and how to minimise it.

Assessing the risks at Wellesley requires a lot of work. After doing so, I find that its performance does not match up to similar competitors:

No detailed information on loan performance

Of the biggest five P2P lending sites (by 4thWay’s adjusted measure of all-time lending), Wellesley is the only one not to open up its full loan book to show the individual situation of every loan it has ever made, updated regularly.

Over time, these loan books show, among other things, if a loan is late or extended, and when it went late, or if a loan has gone bad and how much money is at risk of being lost in that loan. Loan books are typically accompanied by clear definitions, e.g. when a loan is no longer considered just late but as a bad debt.

Loan books with definitions are the gold standard that provide assurance while also making it far easier to assess the quality of the loans.

Also, unlike other P2P lending companies that do bridging and development loans, Wellesley does not provide written information on every individual loan, especially when it is late or goes bad. It doesn’t provide regular individual updates on the status of those loans in terms of debt-recovery tactics and expectations.

Summary statistics

Many P2P lending sites provide clear summary statistics on a page of their websites to get a swift overview of their performance and other useful figures.

A lot of other P2P lending sites, especially small ones, provide no stats at all, which makes risk assessment impossible.

Wellesley is in between.

It provides a statistics page, but information is relatively sparse.

4thWay's timestamped historical logs show that the statistics on the page contain some inconsistencies. These are probably of minor importance but, combined with a lack of definitions for the statistics on the page, it makes it impossible to be certain what much of the data really represents without digging through company accounts or other reports, or by seeking full answers from Wellesley.

The page is irregularly updated. Until this week, for example, Wellesley’s summary statistics page was dated to be over three-and-a-half months old.

Late payments

Wellesley’s filed company accounts for the end of 2015 – the latest published accounts – indicate that nearly 40% of loans were then overdue, albeit mostly by under three months at that time. Wellesley’s response to me last week indicates that more recently the late loans have still been 37%.

Wellesley told me: “Property lending carries extension risk as projects can take longer than was originally planned.”

Wellesley also explained: “It should be noted that this is not an indicator which would imply that all those loans are in difficulty.”

I asked five other P2P lending websites about the proportion of individual property development loans that over-run:

1. “Not many of our development loans go over. There can be occurrences where a development itself might take a bit longer, having fallen out of schedule during the course of the project. “There are times where they might want to maximise the sale depending on market conditions when the project is complete. They might need a bit more time to get a good price. “However this is pretty much a minority situation – not common. We try to look at scheduling and giving plenty of time for the sale afterwards in terms of the length of the loan when we set it live.”

2. “[Our] borrowers (more often than not) make their debt funding requirements for the entire lifespan of the development clear at the outset. For example they may require £2m over two years split into four stages, which would result in four loans over the two-year span. “Due to this nature, one could adjust funding requirements, and corresponding risk and interest rates of subsequent loans, as the development progresses. “Property development tend not to extend beyond the original plan due to the fact that development projects generally decrease in risk as they near completion, enabling the developer to access more avenues of funding.”

3. “The vast majority pay on time or before the loan term.”

4. “We might expect around a fifth or a quarter of property loans to refinance, and the extension periods are normally 3 or 6 months – but this depends on the location and market.”

5. “Around 25% of loans seek an extension for a further 3-6 months.”

 

There’s a lot of variation in their responses between the vast majority of borrowers repaying on time to around 25% requiring extensions. There is also a noteworthy difference between 25% and Wellesley’s 37%.

Bad debts are high compared to other development lending competitors

How do lates correlate to bad debts?

With some digging around and with written responses from Wellesley, I’m pretty sure I have pinned down the intended meaning of some of its statistics related to bad debts on its statistics page, which is tougher than it looks. I’ll try to explain.

With property loans, when they go bad, the hope and intention is that you’ll recover your money by selling the borrower’s property. Losses – or “write-offs” – only occur on property loans if it is not possible to recover all the money from the sale.

Wellesley has had some such losses. It has provided for £4 million in write offs. Just under half of that – £1.7 million – is fully written off. The other half can probably best be described as “charged off”, meaning the loss is deemed probable enough to be recognised in the company accounts.

Wellesley tells me that this £4 million represents 1.1% of all loans it has ever made. While that’s a good figure for many kinds of lending, and possibly good in a property development downturn, it is not low in P2P development lending right now.

As Wellesley wrote: “The lending environment remains positive for Wellesley’s chosen segment of property lending.”

Contrast Wellesley’s figures with both Funding Circle and RateSetter, for example. Funding Circle has matched a similar amount in bridging and development lending as Wellesley, and RateSetter has seen £120 million in development loans successfully repaid.

Both of these businesses have zero outstanding bad debts and zero write-offs or charge-offs on their bridging and development loans.

I estimate that another business I looked into recently, FundingSecure, can currently expect losses of under 0.6% on bad bridging and development loans.

I have talked to other property development lenders who claim to have no losses on any loans over 5-15 year periods, including during the 2008 property crash.

My colleague, bank-risk specialist Leigh Baker, describes property development lending as one the riskiest kinds of lending. (Intrinsically speaking – meaning that P2P lending sites that are very good at it can still dramatically minimise the risks.) If intrinsic risks are higher, I think you usually want to see a combination of low comparative losses in good times in conjunction with high interest rates to compensate for risks.

Unfunded reserve pot

Unlike some other P2P lending sites, Wellesley does not have any pre-funded, separate, protected pots of money set aside to cover excess losses. Instead, Wellesley is aiming to pay for them out of its own pocket.

On top of that existing commitment to cover £4 million (£1.7 million of which is already paid), Wellesley is willing to pay for an additional £4 million in bad debts through what it calls “Loan Provisioning”. That’s a combined £8 million it might pay, provided it can find the cash to do so.

If it can’t stump up enough cash to pay for those losses, or if losses exceed that amount, or if it can’t rebuild the pot quickly enough for future loans, lenders will get hit.

Considering the large potential size of Wellesley’s individual loans, a single write-off could severely eat into lenders’ interest.

Wellesley specialises in development loans up to £20 million, which is far larger than normal. £20 million lent to one borrower could potentially create £4 million in losses all by itself.

So lenders could be highly reliant on Wellesley being able to get hold of lots of cash at all times.

Wellesley hired a risk team in 2016, which I hope will mean fewer bad debts. It will be interesting to reassess risks at Wellesley again when a bit more time has passed and it provides more data.

How valuable is the property taken as security

Wellesley has completed over £360m in loans.

It states that the “value of security held” is over £500 million. “Security” is the property and land that can be sold if a borrower is unable to repay the debt.

The £500 million figure includes security mostly in the form of development sites. As usual for development lending, the “value of the security” is not based on the current or starting value of, say, the empty site prior to any building works or at the time the loan is granted. Instead, it is based on the hoped-for sale value of the development after it is successfully completed.

It’s not just Wellesley: that is standard practice for virtually all P2P lending websites that do development loans. Still, summary information on initial values – while imperfect – would be highly useful to better assess the risk in the loans at all of these websites.

Alternatively, Wellesley could start publishing the actual sale amounts versus projected sale amounts for each individual loan, so that we can see how well it, and its selected developers, actually perform against expectations.

Since Wellesley is also now doing more bridging loans, the security value figures ought to be separated out for both types of lending.

Assessing the risk of Wellesley going bust

Read about The 13 Key Peer-To-Peer Lending Risks Risks for a brief summary of this risk and how to minimise it.

When assessing any P2P lending site, one of the risks to weigh up is the risk of it going out of business.

There can be subtle clues about a business’ prospects all over the place, but audited company accounts can be one of the easiest places to find harder facts as well as points of concern about the risk of any P2P lending company going bust (or, Zeus forbid, the risk of fraud).

The downside is that such accounts can be qualitative and, as in Wellesley’s case, they can be over a year out-of-date. In addition, Wellesley, like all other UK P2P lending services, is a private company, which means its accounts are not as informative as stock-market listed businesses. Lenders and investors have to factor that into their risk assessments and err on the side of caution.

I have the fortune of supplementing the accounts with some additional information supplied to me by Wellesley.

Wellesley’s borrowing

Wellesley has borrowed an enormous sum for a startup – over £43 million – from ordinary individuals. It pays interest on these loans, which are called “bonds”. (Do not confuse its bonds with Wellesley’s P2P loans. The bonds are mostly loans to Wellesley, whereas P2P loans are loans between ordinary individuals and property developers, with Wellesley merely an agent setting up the deals.)

Wellesley has used some of the bond money to cover its ongoing costs and some to grow the business. A large amount of it has been for borrowing to lend.

Borrowing to lend is almost always riskier than lending your own money, and the more that is borrowed the greater the risk. While it can multiply your gains, it can magnify your losses.

It could also be tricky for Wellesley when lots of these bonds become due for repayment. Wellesley is due to pay the entire initial bond back to each bondholder when the bonds expire. Wellesley might need to sell more bonds in order to cover many of those repayments. There’s always the risk that it cannot find enough people to buy its bonds again in future.

Banks effectively borrow to lend vast sums all the time, but they have significant protections that are not available to Wellesley or other P2P lending sites.

If lenders and investors allow themselves to be taken down the borrow-to-lend route, generally you expect to earn higher interest rates to cover those additional risks.

As of the end of 2015, in addition to the £43 million borrowed from ordinary individuals, Wellesley owed a further £15 million.

The latest information we have is that Wellesley pays its bondholders between 5.5% and 8% per year, so we could perhaps be talking £3 million in interest payments a year.

In contrast, Wellesley’s losses in the 18 months to the end of 2015 were £2.5 million, according to its accounts that were externally audited. Wellesley has provided me with unaudited figures for 2016: it brought in £12.5 million for the year which, after costs, left it a loss of £350,000.

Wellesley’s margins after costs are “around 2%”. Margin here means the spread between what developers pay in interest and what Wellesley pays out – its costs, including interest it pays to lenders, admin and other expenses. I’d wish for more that 2% on borrowed money lent on property developments.

No big-name investors

Innovative businesses of Wellesley’s size have often by now received most of their startup funding by selling shares in their businesses to skilled investors, such as venture capitalists, rather than through borrowing from ordinary people to fund costs and growth.

Doing this helps growing startups to better focus on the medium and long-term plan, rather than searching for ways to cover interest payments on loans due the next month.

An additional advantage to substantial startups like Wellesley receiving share investment is that it provides reassurance to its individual lenders. Professional venture capitalists meet an awful lot of startups and do a lot of checks to ensure that the business has good prospects.

Wellesley was seeking to sell some shares through Seedrs, a crowdfunding platform, late last year, but cancelled when not enough interest was raised.

The amount of money injected into Wellesley by shareholders is tiny compared to its borrowings.

Revenue and profitability

Wellesley’s external auditors wrote that from 16 November 2016, Wellesley will need further funding within 12 months, i.e. it will need to sell more bonds or sell more shares in the business in order to keep on going.

In contrast, Wellesley tells me that, by the end of 2016, the second half of that year showed a profit, that it expects to be profitable throughout 2017 and that it does not require funding to be profitable and keep growing.

Both views cannot be right.

Costs are high

Admin expenses rose five-fold, excluding VAT, to hit £14 million over the 18 months to the end of 2015.

That includes marketing going up seven-fold to £6 million and unclassified expenses up two-fold to £2 million. Staff costs are up 10-fold to £4.2 million.

These  investments in the business are made with borrowed money. As lenders, we need to be confident that Wellesley will get enough back from this investment to repay the debts.

Wellesley told me: “It would be expected that expenses will increase as measured from a relatively low base.”

Melwin told me that staff costs of £4.2 million implies an average of £80,000 per person, which seems very high. “Also,” he added, “it’s safe to assume not all staff worked for all 12 months, which means their average salary is way higher than £80k/person.”

Wellesley told me it “prioritized building the right capabilities to support the evolution of the firm over the coming years”.

It added: “We made the decision to invest in the business and its core capabilities. We have hired industry seasoned origination staff, high quality relationship managers, well-regarded credit professionals and strong marketing professionals to underpin the progress of the firm.”

Wellesley has taken some steps to reduce costs.

Director salaries are high

Melwin described director salaries to me as “very high”, at around £1.4 million over the 18-month period when it had losses of £2.5 million. In the previous 12 months, directors were paid £70,000.

Wellesley pays out to lenders even when nothing is coming in

Wellesley promises to pay its lenders (and its bondholders) interest even if their money is not being lent to a property developer.

While that’s nice when you’re winning, this could put short-term pressure on Wellesley, much like borrowing to lend.

During times when it’s difficult to find plenty of good borrowers, more money might be sitting idle. Wellesley might then need to lower the interest rates it pays to lenders so that it doesn’t lose too much money. However, it can take years for lower rates to filter through, due to lenders being offered fixed rates of interest.

So Wellesley might have to try to swallow the costs in the form of losses, while it sits and waits for the property development market to turn around.

The only other alternative in that situation would be to accept worse borrowers, something Wellesley’s new risk team will seek to avoid. The effects of poorer-quality loans in terms of higher losses would not be seen for 12-24 months.

Late company accounts

Wellesley’s latest group accounts were several months out-of-date. So late that it received a warning from Companies House, the UK’s register of companies.

Another of its three main businesses in the group, Wellesley & Co Limited, is currently in the same boat, with accounts three months late. Wellesley says they were signed off on the 20th January and they will be filed five days later – so hopefully some time today.

Note that even when those accounts are published, they still will only be correct to the end of 2015, making them over a year out-of-date. Wellesley’s audited 2016 accounts are not due to be filed until the end of September 2017.

Wellesley explained that the accounts are late due to changing to a different accounting system.

Three director resignations

Melwin considered three director resignations to be sufficiently interesting in his experience to point it out to me.

Wellesley told me: “As a small startup there will be resignations.”

P2P lenders became property developers in Spain

A large loan went wrong and Wellesley took the step of becoming a 50% part-owner in the development. Hence Wellesley is now a real-estate developer in Majorca, Spain.

Did lenders sign up for becoming investors in Spanish development property?

It looks like Spanish development loans were for a total around £10 million. Wellesley had largely mitigated its exposure to swings in the euro using derivatives (which is basically insurance against losses when the pound-euro exchange rate moves against you).

Wellesley said it lent on four loans in Spain, one is repaid and it doesn’t intend to do any more. It added that it does not forecast any losses on these loans.

Loans to the chief executive officer

Graham Wellesley, the CEO (the head of the company), recently took out a loan of around £1.7m from Wellesley in order to buy more shares in Wellesley.

Wellesley told me that the money is to pay for written-off property loans. If you recall, £1.7 million is the same amount that Wellesley told me has been fully written off.

(It is quite possible that bondholders’ money also cannot be used directly to pay for losses. Hence, if the the CEO can borrow that money off the company and put it back in the business by buying shares, Wellesley can then use the money to pay for losses. I’m just speculating wildly there; I don’t fancy re-reading the lengthy bond contracts again right now.)

Taking this unusual step to cover losses, I ask: Are bad debts worse than Wellesley expected, is its financial position worse than it expected, does it not have any money in the pot to cover losses, or was it always the plan to pay for bad debts in this way?

The CEO has favourable terms on his loan, paying just 10% interest. It is secured against one of his properties. I have no information about how valuable the property is.

Here’s Wellesley’s full response about this:

“Graham was keen to ensure that he personally paid the cost of these early impairment losses and, in order to ensure that he could take all of the costs without having to do an immediate sale of personal assets, the directors of the company agreed to provide him with a loan. This loan is monitored by the independent non-executive directors.”

What Wellesley could do to turn it around

I usually end a piece with tips for lenders, but here it’s tips for Wellesley, because I would really like to see it do well for itself and its lenders.

Wellesley reassured me three times last week that it is going to increase disclosures further. Perhaps only the passage of time can provide answers to some of the facts I raised in this piece, but Wellesley could help lenders much sooner with the following kinds of disclosures and changes:

• Work to reduce bad debts and the risk of heavy losses from single loans going bad.
• Hire someone to produce regular reports and statistics who doesn’t find accuracy or clarity quite so distasteful! (I know. You're thinking I'm a hypocrite after reading this. But I'm not paid £80,000 per year.)
• Begin a new era of transparency combining a) the sorts of data and information that the other large P2P lending sites offer with b) the best reporting from other development lending P2P sites, down to individual loan level. This means monthly detailed loan books containing key information on all historical loans and clear definitions, as well as brief written reports on the status – and debt-recovery situation – of every single loan and development.
• Publicly and pro-actively put out summary statistics and information in a way that leaves few, if any questions, on simple pages of the website for all lenders to see.
• Try to find ways to offer more reassurance to lenders that Wellesley’s own debts and costs are easily manageable.
• Look for opportunities to raise lending interest rates as soon as it is safe to do so.
• Rush out its audited 2016 group and subsidiary accounts at lightning speed.
• Provide as much information as possible to show why it believes it will be profitable through 2017.

Read the follow-up articles:

Wellesley Is Still A Sell, 6th July 2017.

Wellesley Update Since The 2017 Tip, 4th May 2018.

Minor details might have changed between the time of conducting the research and the publication date, but nothing significant has happened that has changed my conclusions.

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