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Has Anyone Lost Money At Lending Works And How Variable Are Lending Results? (P.S. Please Don’t Unsubscribe)
Lending Works* states that no lender has lost money while some Lending Works lenders have written to us saying that they have. What's really going on?
This article has two parts:
- Firstly, to talk about whether any lenders have suffered an overall loss at Lending Works.
- Secondly, to look into how much the returns have varied between lenders using Lending Works who were impacted by the pandemic.
Have any Lending Works lenders lost money?
Due to the pandemic, Lending Works* put existing lenders on negative interest rates for a few months to divert some extra money to its bad-debt reserve fund. Some existing lenders still have negative rates on some of their loans, while loans issued in 2020 are now back on track. 2021 loans are unaffected.
Reserve funds in P2P lending are not to cover all losses under all circumstances, but rather to cover mundane losses. The interest that lenders earn is the next – and usually larger – barrier against making a loss from higher bad debts.
So the key question is whether any lenders who faced negative lending rates ever had less money than they started with on the batch of loans that has been hit by the pandemic.
So I asked Inês Maia, Lending Works' Chief Risk Officer, the single question:
“Are you saying that no investors have experienced negative interest rates that have at any point (temporarily) outweighed prior interest earned (based solely on the loans they had outstanding on 30/4/2020)?”
To which the response was: “Yes that is exactly the case.”
Some individual lenders disagree, although we've seen no evidence
Some individual lenders are telling 4thWay that they reckon they were sitting on overall losses, at least temporarily. Up to this point, none of them have provided us with data to support these statements. (Please do send it in, if you have it.)
Lending Works' own data and information provided to 4thWay has been reliable over the years, so I have no reason to doubt what Lending Works' top risk officer says at this time.
Lending Works tells us it applied negative interest rates only to loans that have earned prior interest, so that the negative rates offset some past earnings. Since no lenders have had negative rates on any individual loan in excess of the money they lent on it (or provided evidence to us of this), they have not lost money.
In this sense, the negative interest rates are the equivalent of loans turning bad in a downturn at P2P lending platforms that have no reserve fund. On such platforms, those loans that have turned bad eat into the existing returns on your outstanding portfolio of loans. If a large property loan turns bad, it could outweigh the interest you'd earned in your most recent months, which is the equivalent of negative rates contracting some of your previous gains.
It's possible that lenders who reckon they have suffered a loss are looking at their annual results rather than the overall performance of their investments – their loans.
If you compare this to the stock market, if you buy shares at £5,000 and they rise to £8,000 one year and fall to £6,500 the next year in a downturn, you still say you are in profit on those shares, despite the bad year. You don't say you've made a loss on those shares, because your investment horizon was not that single calendar year.
And that's precisely in line with the natural way to assess the results of money lending, because the natural investing horizons in money lending is from the time you lend to a borrower, until the time the borrower repays.
What if Lending Works has explained it wrong?
Although we've checked this quite carefully, I still have a little feeling there's a small chance that Lending Works has muddled its wording when explaining how it's applied negative lending rates to 4thWay, leading to a misunderstanding. (I'm always on the lookout for misunderstandings from loose language, so I'm being typically over-cautious in bringing this up.) Just possibly, it meant to say that some individual loans have lost money by being hit with more negative interest than prior interest earned. They might have meant that, on any lender's batch of loans, no-one has lost money overall.
Even so, in that hypothetical situation, that's still an overall profit on investments for all lenders. Albeit not as satisfying.
A note on Lending Works' historical 4thWay PLUS Ratings
Those who are disappointed with Lending Works for what they've got wrong might also be angry enough with 4thWay continuing to persist in saying that the risk-reward balance in terms of interest earned, the reserve fund and bad debts, remains excellent. I even expect some readers to unsubscribe from 4thWay. But we have to follow the facts and not be swayed by the most vocal critics.
Before I get to how returns vary between lenders, here's a quick aside on Lending Works' historical ratings, which are linked to the historical positive returns I am talking about on this page. (We have another article published today about Lending Works' current ratings, not its historical ones. Current ratings are based on an assessment of future results for lenders who lend money today.)
The top 4thWay PLUS Rating is awarded for lending accounts where we calculate that by the time you repay all your loans in a portfolio of similarly-rated lending accounts then you can expect to still make money by the time all your loans are repaid, even if there's a major (1-in-100 year) recession and property crash similar to 2008.
In this way, we are using much stricter versions of the Basel stress tests that banks are required to use.
We've just had what was actually by one strong measure a 1-in-300 year downturn – albeit with no property crash, which would also indirectly impact Lending Works' unsecured lending. No two downturns are identical, but Lending Works' bad and late debts on impacted loans are still lower than we calculated for our stress tests at this stage. And, based on the latest data available, it simply doesn't look feasible at this stage that existing lenders could make losses due to the pandemic. Even if we factor in more bad debts later when government support to borrowers ebbs away, it's not likely to happen to any lenders.
So the evidence is good that Lending Works has really not done badly at all under the circumstances and it has not underperformed its 4thWay PLUS Ratings.
How variable have lending results been since the pandemic?
In addition to stating that no lenders suffered even temporary losses due to negative interest rates, Lending Works* head of risk confidently forecasts that all lenders “will have a positive return over the lifetime of their loan portfolio.” This correlates with our own analysis of Lending Works data. At this point in time, it would be truly surprising if any lenders make an overall loss on their investments.
That doesn't tell us about results at an individual level, however.
Each downturn impacts the many types of borrower or types of loans differently, and individual borrowers seem to be among the worst hit this time round. Certainly this is the case with Lending Works' borrowers. As a result, Lending Works now expects that around 30% of lenders who were lending last year will now earn less than half the advertised target lending rates. (That doesn't apply to new lending that existing or new lenders do this year. See the 4thWay PLUS Rating Updates On Lending Works for more on new lending.)
Around 20% of lenders who were lending last year will earn 90%+ of the target rates and half of lenders are on course to earn between 50% and 90% of the advertised target rates.
This is far more variability and much lower returns than lenders will have wanted, yet it's still far greater stability than the stock market. Many people investing in shares panicked at the start of the crisis and sold their shares. Thousands of them will have sold for a loss. Typically, at these times, jaded investors choose then not to rejoin the stock market until prices have risen far above what they sold for. Selling low and buying high; it's all psychological.
Many who were lending in P2P also panicked, but were saved by the fact that they were doing direct lending, which enforces discipline whether you want it or not: because you're unable to sell early at panic prices. (Indeed – in Lending Works' case, unable to sell early even for the same price you paid for your loans. That's the flipside of investments with greater stability; potentially slower access, particularly during downturns.)
Inês Maia wanted to make the point that: “While any deviation from target returns may be disappointing, this has to be viewed in the context of the current unprecedented environment.”
That's for sure.
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The 4thWay® PLUS Ratings are calculations developed by professional risk modellers (someone who models risks for the banks), experienced investors and a debt specialist from one of the major consultancy firms. They measure the interest you earn against the risk of suffering losses from borrowers being unable to repay their loans in scenarios up to a serious recession and a major property crash. The ratings assume you spread your money across hundreds or thousands of loans, and continue lending until all your loans are repaid. They assume you lend across 6-12 rated P2P lending accounts or IFISAs, and measure your overall performance across all of them, not against individual performances.
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