Orchard Funding – history and competitive position

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Orchard Funding (LSE:ORCH), a company I bought into this week, is a small player in an industry dominated by two giants. Nevertheless, it has been profitable in each of the last ten years. Indeed, it was growing profit steadily until Covid-19, so there must be some degree of protection from the big boys bullying the firm out of its markets.

Bexhill

Ravi Takhar, CEO and 53.3% shareholder, took control of a small company in 2002. A subsidiary, Bexhill, was created that year to target clients of insurance brokers by lending to them for up to 10 months. Monthly repayments meant that the money returned to Bexhill pretty quickly.

By 2014 Bexhill had about 100 broker clients who arranged loans for policyholders so that they could pay their insurance policy premiums upfront (it now has 150 insurance broker partners). Annual advances were about £30m (at any one time only £10m – £15m was outstanding) which generated revenue (interest) of £1.8m. Profit after tax was £0.87m.

Orchard Funding Limited

The second strand to the company’s lending was conducted through Orchard Funding Limited. From a standing start in 2010, by 2014 this subsidiary was lending money to clients of 400 accountancy practices. In early 2015 its loan book stood at £8m having lent about £16m over the previous 12 months.  Annual revenues (interest) were £1.17m and profit after tax £0.15m.   It had 2,236 borrower agreements, with an average loan value of about £4,000.

Floating on the stock exchange

On joining AIM in 2015, in which it raised £10m gross or £8.7m after financial advisers had taken their cut, the directors were able to proudly state that the business model was so good that there had been “no arrears or losses on the lending book of the Group over the last seven years” (Admission document). We’ll look at the reasons behind this impressive statement by a lender later.

There were then only 11 members of staff so operating costs were low. Even today there are only 22.

A good net interest margin, low operating costs and low/no default meant that the business was cash generative leading the directors to declare a high ambition for dividends: “As the Group is cash generative it is the directors intention to implement a progressive dividend strategy” (Admission document).

Technology

Staff numbers could be kept low because it had, for 13 years, been improving its processing platform for loan proposals, with feedback from daily use. By 2015 it was used on 100 insurance brokers’ and 400 accountancy firms’ computers, processing each year transactions for over 3,000 borrowers.

Delivered via the internet it incorporated all the systems, procedures and documentation required by an insurance broker or an accountancy firm to introduce its clients to the Group and conduct a finance business. It also managed all the agreements, calculated funding requirements and performed all day-to-day accounting and administrative tasks of the Group.

Growth

On flotation the directors said their aim was to double the size of lending from its annual £46m. They were going to do this by (a) increasing the number of insurance broker and professional firm clients, (b) increasing the volume of business from existing brokers and accountancy firms.

Some of the extra £8.7m raised in the float was useful for handing out to brokers and accountancy firms as commission when they persuaded a client to take credit. Money was also useful for reducing financial risk, i.e. not having to borrow so much from Barclays; until that point about 75% of the money lent was obtained from Barclays, after the float one half came from Orchard’s own cash resources.

Size of market

While the general insurance market is about £50bn per year only a fraction of policyholders choose to by on credit, about £9bm to £12bn.

The potential of the accountancy fee finance market was given a boost at the time of the float by the banks pulling out of market for small-ticket, short-term, unsecured funding. The addressable market was perhaps £300m.

Low defaults

Orchard has multiple layers of credit protection:

  1. Customers feel they must pay. Failure to pay insurance premium finance obligations may leave the borrower uninsured and therefore unable to operate essential day-to-day activities. Likewise, clients of accountancy firms know they must satisfy their accountancy fee obligations in order to file important documents such as tax returns.
  2. Early payment.  Orchard receives the first payment from the customer before funding is issued to the insurance broker or accountancy firm, thus eliminating first payment default.
  3. Delay in paying commissions. On average Orchard pays commission to brokers and accountants 30-45 days after entering a credit agreement. One and a half instalments from the borrower are already in the bag by then.
  4. Direct debit collection. A timely collection and traceable link to the customer.
  5. Short duration. The weighted average time to receive the full repayment is under six months.
  6. Cancellability. The borrowing facility can be cancelled by Orchard at any time.
  7. Insurance carrier rebate. Cancelled insurance policies before the end of the full term usually result in unearned premiums being rebated by the insurer. Thus, if a customer ceases monthly payments the insurance company will receive notification to cancel the policy and pay a rebate. At any time unearned premium rebates will exceed the loan value due to Orchard’s strict repayment structure.
  8. Recourse to insurance broker or accountant. They guarantee repayment.
  9. Regulation. Industry bodies such as FCA regulate say brokers limiting poor behaviour
  10. Government insurance. The Financial Services Compensation Scheme provides pays out in the event of insurance company or broker failure.

Competition

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