Wellesley Update Since The 2017 Sell Tip

I'm very much in the “sell Wellesley” camp for the dozens of reasons mentioned in an article on Wellesley by one of 4thWay's experts early last year, as well as in information elsewhere on the 4thWay site.

At every turn, we encounter conflicting, ambiguous or insufficient information from Wellesley & Co.*, which might at least partly explain the varying opinions 4thWay readers have expressed on its latest bad-debt results announcement this month:

“The impact on me is that my Wellesley overall returns will be only marginally above a long-term bank bond interest rate – but with significant extra capital risk.”

“I am just being suitably stoic. I think you have to accept some bad loans in P2P.”

“What happened to the contingency fund that I seem to remember when I joined? Surely this is exactly the situation it was designed for.”

However, Wellesley & Co.'s new bad-debt figures, assuming they are correct and relatively transparent this time, are not as worrying as they might seem on the surface. Not when those figures are taken entirely by themselves, at least.

I'm not complimenting the figures, just saying that there may be less to worry about than at first glance. Because there's a lot to worry about at first glance.

Indeed, one defensive feature of Wellesley could save the day for lenders.

Or not.

I'll start with the positive look at what the latest figures might mean for Wellesley lenders, but don't get comfortable because I will then finish with the counter attack.

Firstly, be clear on Wellesley P2P lending vs Wellesley bonds

Before I do that, I just want to make something clear: 4thWay provides ratings and research for direct online lending between individuals and borrowers, aka peer-to-peer lending.

So I'm writing with lenders in mind who put money into Wellesley's P2P lending accounts and who are thus lending their money directly to individual property borrowers.

I'm not writing about the investors who put money into Wellesley's bonds, many of which were not loans directly between individuals and property borrowers, but rather loans from individuals to Wellesley itself. That's a different product with potentially very different – and increased – risks.

How Wellesley's P2P lenders could be okay

Losses so far

Wellesley has now reached £13.4 million in loan losses, according to information we obtained on the 1st May 2018.

Around £8.5 million is “capital losses”, which means losses to the initial property loans, which is double the amount reported by Wellesley at the end of last year. The other near-£5 million is loss of interest.

We don't know how much of those capital losses are completely done and written off, since Wellesley is unusually vague with its banking terminology. It's possible that at least some will be returned after unexpected recovery results, but personally I shall assume the worst.

Losses mostly covered by Wellesley, on behalf of lenders

Wellesley has covered – or will cover – a staggering £10.8 million of these losses itself and passed on just £2.6 million of losses to lenders.

Wellesley has paid for those losses with no segregated, pre-funded reserve fund, which can seriously rock the stability of a P2P lending site. The most attractive and stable way for a P2P lending site to cover losses from its own pocket like this is if it can afford to do so entirely from the interest and fees that it itself earns on loans.

And, trying to be positive, it is conceivable, that the £10 million in losses are covered in that way, because the interest and fees that Wellesley itself earns on loans could be substantial: while Wellesley passed maybe 5% per year to lenders on average, it could have been charging 10-20% to many borrowers, with arrangement fees on top.

Interest earned by lenders outweighs losses

Wellesley also claims to have already paid £19.9 million in interest (although it is unclear if that has been paid to its P2P lenders, or to both its P2P lenders and bondholders).

So the interest of £19.9 million currently tops the £13.4 million in declared losses and it would have covered the losses for the average lender even if Wellesley hadn't stepped in for £10 million itself.

Wellesley backs all that up by stating on its website that lenders have earned 4.11% annual interest, after losses.

We know that Wellesley also believes the average interest rate for P2P lenders is just down by 1.01% after losses, which means even lenders who opened a Wellesley P2P lending account when it was paying little more than 2% annual interest should still be in the plus.

Losses outweighed by size of loan book

In addition, Wellesley states a total historical loan book of £670 million. It is unclear whether this is just P2P loans or whether this includes bondholders. Either way, it is sizeable compared to the losses Wellesley says have been made.

Wellesley lenders' defence against losses

The big feature that Wellesley offers to protect lenders is automatic diversification across all its loans. This means that, in theory, a whole lot of loans usually have to go badly wrong before most lenders should expect a loss, and it means that losses are evenly spread amongst the lenders. That's even if Wellesley covers no losses itself.

All that seems to indicate that all Wellesley's individual P2P lenders should all currently be afloat and that the average lender could even take multiple new hits before making an overall loss.

Now the flipside…

The background

Aside from the many outstanding points in last year's Why I'd Sell Wellesley Loans and the follow-up, Wellesley Is Still A Sell, the new bad-debt figures above also leave a lot of unanswered questions.

Wellesley spent fast to advertise, employ more people and grow rapidly, and paid very large amounts to its directors in the process.

And that's all while borrowing tens of millions of pounds from individual investors for itself (through the bonds I was talking about), which should make any investor think twice about its stability and soundness, especially in a property-market downturn.

So how has Wellesley funded losses?

And yet, with all those costs, Wellesley says it also found £10.8 million to fund losses, which is a vast sum, considering it has had no special, segregated reserve fund set aside to cover losses. Wellesley has mentioned before that it provides for at least some of the losses itself using “equity”, which means it probably isn't covering losses using the fees and interest it has earned.

It could also mean that the losses have not yet been paid for at all, leaving a huge black hole to be filled at a later date.

What does 4.11% really mean?

As I wrote above, the Wellesley website says that its P2P lenders earn 4.11%. Again, there's a typical conflict of information from Wellesley, with the website stating that P2P lenders have already earned this amount, whereas private information obtained by 4thWay states that 4.11% is an estimated return.

Is that an estimated future return or is it that Wellesley hasn't sat down to calculate the historical return properly?

Confused? That's par for the course for Wellesley's transparency and plain speaking.

What other figures are unclear?

With Wellesley's history, well-documented by 4thWay, it would not surprise me if there is a similar anomaly in its total interest figures. It states £19.9 million of interest has been paid, but I believe some Wellesley accounts don't pay interest to lenders on a monthly or even annual basis.

So have lenders really received all that interest, or is some of it just promised to them? If it has been promised to them, has it been legally ringfenced for them?

In a similar point: is the £13.4 million in losses referring to all property loans Wellesley has made or just the loans funded by P2P lenders? As usual, this is not clear. However, if it is the latter, it means more losses could be piling up somewhere that could impact the stability of Wellesley itself.

Forecast losses constantly exceeded

It really doesn't look good that we have on record here at 4thWay that Wellesley has consistently forecast losses of 1% for each calendar year, and yet losses have consistently exceeded forecasts in all matured years.

A handful of extra bad loans could lead to losses

10 loans out of 281 have led to actual losses so far at over £1 million in losses per loan, on average. For the record, that's a lot. These are supposed to be loans secured on property and Wellesley has even told 4thWay that its focus in approving loans is on the security.

Wellesley has approved loans up to £20 million in size, with £4.5 million the average. These are huge loans.

So, even after recovering some of the bad debt by selling security, it might take no more than about five additional loss-making loans to wipe out the average interest earned so far and cause most lenders to make a loss.

Considering we haven't just been through a recession or property crash, this is much closer to the edge than we are used to seeing in P2P lending.

I can also find no statistics from Wellesley that show how many loans have gone bad but not turned into losses yet or any serious information about any loans they are watching closely for potential issues. That is really poor transparency on Wellesley's part.

Is Wellesley's auto-diversification reliable?

As to Wellesley's auto-diversification across all outstanding loans, some lenders have questioned how Wellesley has legally locked that system down, which becomes especially important in the event Wellesley closes. Is it watertight? Some P2P lending sites have had to close their auto-diversification features before receiving full permission from the regulator, having found that the regulator did not approve one or more aspects of their setup or transparency.

The question of how auto-diversification works – and if it will always work – is pertinent for a P2P lending website like Wellesley that has suspended new lending in its P2P accounts for a long time and still not received full permission from the regulator to operate as a P2P lending platform. Where is its permission?

The bottom line is that these are all just more for questions for the pile.

Even if Wellesley were to come out and answer all the questions in this article in plain English and sufficient detail, it leaves a million more unanswered. The overwhelming difficulty in getting clear, complete and reliable information from Wellesley probably leaves many lenders wondering how much longer they want to remain involved in such a proposition.

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