Equity Developement Template - ArchOver · (TrustBuddy) and China (Ezubao) last year. 0.0% 1.0%...

ArchOver Ltd

Please refer to the important disclosures shown on the back page and note that post MiFID this information is categorised as Marketing Material

How to make a “relatively safe” 5% pa return

Looking for a decent, yet none too risky, return on your hard earned cash? It’s almost

impossible nowadays. Indeed, spend a couple of minutes surfing the internet, and one

of the best deals currently available is a 2 year bond paying 2% pa from the Bank of

Cyprus. Not especially appealing, but neither is a 1.5% yield on 10 year UK gilts, while

Buy-to-Let properties have just got more expensive after a 3% hike in stamp duty.

Luckily there may now be a solution – investing in P2P loans either directly through an

online platform, or via the government’s newly created tax efficient ‘Innovative Finance

ISAs’. There is plenty of choice too, ranging from volume players like Zopa, RateSetter,

Funding Circle, and MarketInvoice, to the niche providers, such as ArchOver.

The beauty of P2P is that its cost base is circa 2x-3x lower than the traditional

banks. So, by cutting out the middleman, lenders and borrowers alike are both able to

enjoy superior terms. In fact, we reckon that going forward, across the economic

cycle, a diversified portfolio of P2P loans should be able to generate ‘relatively

predictable’ returns of circa 5% pa (net of costs/defaults).

Some of the best investments in the P2P sector

The big question, though, is how safe are these investments, given that they are not

covered by the Financial Services Compensation Scheme? Well, on the evidence of the

2008/9 financial crisis, we think the P2P sector’s overall credit vetting procedures are

at least on a par with the high street banks. Plus, if you’re seeking even greater

protection, then ArchOver, a specialist in funding to SMEs (small, medium sized

enterprises), could be the answer.

It not only completes extensive due diligence before any money is released, but

also its loans are ‘secured’ (with an ‘all-asset debenture’ charge held at Companies

House) over the borrower’s Accounts Receivable balance, with the collateral being further

‘insured’ by Coface, a €1bn+ market cap business (COFA.PA) listed in Paris. This

insurance layer acts as both a robust 3rd party, independent validation, and an extra

level of reassurance for lenders.

To date, ArchOver has arranged 81 loans - worth collectively £15.2m at an average

interest rate of 7.2% - incurring no late payments. What’s more, the finance is fully

committed for the duration of the contract, and therefore shouldn’t fall into the same

liquidity trap that went so spectacularly wrong at Northern Rock. In terms of credit

quality, we estimate that ArchOver’s loans lie broadly in the band between S&P’s lower

investment grade (BBB) and upper high yield (BB-) ratings.

CEO Angus Dent adding “the group was the fastest growing P2P working capital lender

in % terms last year and in Q1’16. Additionally we believe our unique ‘Secured and

Insured’ proposition, offer lenders some of the safest fixed income yields

available within the P2P space."

To us, ArchOver’s differentiated business model is best of breed, and perhaps even

represents the future of corporate lending to SMEs worldwide

18 April, 2016

Description

ArchOver operates (what is believed to

be) the world’s only “secured and

insured” Peer-to-Peer (P2P) lending

platform, which aims to minimise losses

- as well as avoiding the need for

personal guarantees, which is often

disliked by company directors/owners.

Its loans to SMEs (small, medium sized

enterprises) tend to be for 3 months - 2

years in duration, and worth between

£100k - £5m, which is higher than the

industry norm, thus making the

economics more attractive.

Approved borrowers typically pay

interest of 6.25% to 8.25% pa, with

lenders receiving 5.75%+ pa (post

fees), dependent on term and the

type/quality of collateral.

On top of an annual 1.5% processing

margin, ArchOver levies a one-off 4.8%

marketing fee from the borrower to

cover initial credit checking and setup.

The business focuses solely on high

quality commercial credit, and is

majority owned and backed by the

Hampden Group (£60m of net assets).

Finally, ArchOver is authorised and

regulated by the FCA, along with being

a past Altfi award winner for its Working

Capital Facility.

Paul Hill (Analyst)

0207 065 2690 [email protected]

Hannah Crowe 0207 065 2692 [email protected]

ArchOver Ltd 18 April, 2016

2 www.equitydevelopment.co.uk

P2P sector is growing up fast

Today Facebook, Amazon, Netflix and Google are worth in aggregate £1.1 trillion. However

this wasn’t always the case. Turn the clock back 20 years, and two of the FANGs didn’t even

exist, while the others were mere start-ups. So what about another ‘disruptive technology’,

online P2P finance (see below)?

Well, the sector has enjoyed tremendous growth over the past 5 years, driven by internet

disintermediation (ie cutting out the middle man), materially lower costs, savers seeking

higher returns, borrowers requiring cheaper finance and bank deleveraging, post the 2008/9

financial crisis.

P2P Lending vs old-style banking model

Source : Prosper (2nd largest American P2P platform)

Cost advantage is not going away anytime soon

In fact, by not being burdened by expensive branch networks, head offices, legacy fines (eg

PPI) and antiquated IT systems – overheads for P2P operators (ie once they have reached

scale) can be circa 2x-3x lower (as a % of assets) than those of the old-school banks (see

next graphic):

Lendingclub’s expense base as a % of outstanding loans

Source: Lendingclub (World’s biggest P2P listed stock – LC. NYSE)

18 April, 2016 ArchOver Ltd

www.equitydevelopment.co.uk 3

Importantly too, this substantial cost advantage is not going away anytime soon -

meaning that the industry should have plenty of years (if not decades) of strong growth ahead

of it. A fact borne out in the data, where according to a study from Nesta/Cambridge

University in February 2016, the UK P2P ‘alternative finance’ sector jumped 84% last

year (see below), placing £3.2bn of funds.

£3.2bn UK P2P ‘Alternative Finance’ industry (£ms)

Source : Nesta and Cambridge University

Within this P2P consumer and business lending (including real estate) climbed 66% to £909m

and 99% to £1,490m respectively – with the latter representing 2.7% of gross and 13.9% of

new borrowing to SMEs. We think this secular trend will continue with P2P business loans

tipping £10.1bn (see below) by 2022.

Forecast growth of UK P2P business lending market (£’ms)

Source : 2012-15 in blue (source: Nesta), ED forecasts in green (2015-2022)

1,490

909

325

332143

P2P Business lending P2P Consumer lending

P2P invoice trading Equity Crowdfunding

Others

62 193749

1,490

2,251

3,592

5,290

6,682

8,078

9,225

10,101

0

2,000

4,000

6,000

8,000

10,000

12,000

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022



It isn’t all about the little man on the street either, investing their hard-earned cash -albeit

1.09m did so in 2015. Today professional money is also pouring into the sector, with 32% of

P2P consumer and 26% of business loans being funded by institutions (source: Nesta and

Cambridge University).

Industry bifurcation as it moves mainstream

The good news is that, despite there being more than 100 P2P operators in the UK, it is

becoming increasingly clear who will be the eventual winners and losers. Here, in our view,

the market is polarising between the volume players - Zopa, RateSetter, Funding Circle,

LendInvest and MarketInvoice – and the niche specialists, such as ArchOver (see later).

The upshot being that many in the middle ground will get squeezed, and ultimately may not

survive the industry’s forthcoming ‘Darwinian’ shakeout.

This is also consistent with the decline in the number of new entrants over the past 2 years

(see next table), as P2P moves into the ‘mainstream’ on the back of greater public/business

awareness, regulatory protection and economies of scale.

Industry consolidation in motion

Source : Nesta and Cambridge University

Attractive returns in a ‘low rate for longer’ environment

Therefore, unlike Lord Adair Turner (previous head of the FSA, now FCA), who warned the

BBC in February that P2P lending would wreak havoc over the next decade, we still think that

it is possible for risk tolerant investors to generate healthy returns from holding a basket

of non-correlated, fixed income P2P loans in today’s low interest rate environment.

Take Funding Circle, a volume P2P lender, who has already raised more than £1.3bn for SMEs

in the UK, US, Germany, Spain and Netherlands. It provides a range of different investment

options – the riskiest offering 18% pa gross, with the safest at 8%. Net returns though

typically fall into the 5-8% range (see next table) after adjusting for charges and defaults.



Investor ‘net’ returns from Funding Circle

Source: Funding Circle

Going forward, even after factoring in a recession, we reckon that a diversified portfolio of

P2P loans should still be able to deliver returns (net of costs/defaults) of circa 5%

pa across the economic cycle (see below).

Estimated ‘net’ returns from P2P loans vs other asset classes

Source: Equity development estimates (after defaults/costs)

Taking up the regulatory baton

From a fiscal perspective, the government seems to be supportive too. P2P lenders are already

regulated by the Financial Conduct Authority (FCA) – and possess capital buffers of at least

£20k (rising to £50k+ in April 2017). We think these regulatory ‘checks and balances’ are

important in building investor confidence, especially following the alleged frauds in Sweden

(TrustBuddy) and China (Ezubao) last year.

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Better still, for the 1st time ever, from 6th April 2016, P2P loans can be included within

new ‘innovative finance’ ISAs - albeit these tax efficient vehicles are still relatively thin on

the ground, since the FCA has had difficulties processing applications. In fact, as of today we

understand there to be 86 firms awaiting “full authorisation”, and only 3 (Abundance,

CrowdStacker and Crowd2Fund) who have both been granted regulatory approval and

published details of their ISAs.

Ok, but where is it ‘relatively safe’ to invest in P2P, whilst at the same time earn a decent

return? Well ArchOver could be the answer. Its sweet-spot is providing business loans

to SMEs in the £100k - £5m range over terms of between 3 months to 2 years.

Turning P2P loans into an art form

Prior to authorising any deals, the company conducts detailed credit vetting, involving

face-to-face meetings and the mining of 3rd party databases – only approving creditworthy

borrowers with at least 2 year trading histories. These SMEs must also possess good quality

trade debtors, whose balance is monitored each month - and over which an ‘all-asset

debenture’ charge is held at Companies House with LTV (loan-to-value) cover of at least

125%.

Personal guarantees are not required, hence providing a key benefit to the directors who

otherwise might have been forced to put their houses on the line. Lastly credit insurance is

arranged against the collateral using Coface, a €1bn+ marketcap group listed in Paris

(COFA.PA).

All in all making these “secured and insured” P2P loans homogenous in terms of risk, thus

permitting the interest rate to remain constant throughout the term. Further security comes

from ArchOver’s position as ‘Joint Insured and Loss Payee’. Meaning that in the event of

default by the SME, both the collateral and/or the insurance proceeds can be transferred

quickly for the benefit of lenders.

We believe this proposition achieves the best of both worlds for borrowers and lenders alike,

and should be considered as best practice for the P2P industry.

ArchOver’s differentiated “secured and insured” P2P model

Source: Company



Interestingly too, a recession might actually work to ArchOver’s advantage, since it could lead

to a demand surge as investors seek greater protection, and borrowers are starved of credit

by the banks again. This is exactly what happened following the 2008/9 financial crisis, when

the major institutions pulled back on their lending activities.

With regards to credit quality, we estimate ArchOver’s loans broadly lie in the band between

S&P’s lower investment grade (BBB) and upper high yield (BB-) ratings.

Fixed income returns (gross) of 5.5-7.25% pa are typical, with ArchOver managing the

supply/demand dynamics of the marketplace, along with facilitating interest payments and

debt collection. In return the company charges a 1.5% pa margin and separately levies

a one-off upfront 4.8% marketing fee. A small commission is earned from insurer

referrals, with the cost of this also being borne by the borrower.

To date the group has arranged 81 loans - worth collectively £15.2m at an average interest

rate of 7.2% – incurring no NPLs. What’s more these agreements are fully funded, so

they certainly shouldn’t fall into the same liquidity traps that went so spectacularly wrong at

Northern Rock. Approx 80% (in value terms) of its lenders are institutions, usually

conservatively minded, single family offices, charities, etc - with the remainder private

individuals.

Lastly, in the very unlikely event of bankruptcy (since 70% owned and funded by the

Hampden group), ArchOver’s ‘Living Will’ would be triggered, thus enabling all existing

contracts to be transferred quickly and smoothly to another provider.

So what does this all mean?

Well, we think ArchOver has developed a highly differentiated and attractive P2P

proposition, which is why in February 2016, Duradiamond Healthcare selected it to provide

a record £2.3m working capital facility. The loan consisted of 3 parts, generating returns

(after fees) for lenders of between 6.25% - 8.0%.

CEO Angus Dent adding “Not only does this represent a record loan for ArchOver, we also

believe it is be the largest non-property related working capital loan in the crowdlending sector

anywhere in the world”.

In terms of competition, the company’s main rivals are the traditional invoice discounters

rather than other P2P operators, albeit MarketInvoice has been aggressive of late with regards

to pricing. Longer term we believe sector consolidation will occur, with the company perhaps

ultimately being acquired by a larger player and/or a bank, wishing to enter this space.

Conclusion

The P2P sector appears to have an attractive future ahead of it, involving plenty of

years (if not decades) of strong growth. Advances in technology will continue to keep

costs down, while low interest rates should further spur investors to seek higher returns, as

well as encourage borrowers to look for cheaper and more flexible credit.

ArchOver’s unique “secured and insured” proposition represents industry best

practise and, in our opinion, is a powerful differentiator to attract lenders and creditworthy

borrowers alike.



Key risks

There are currently >100 P2P platforms in the UK. In our view this is too many, and

inevitably will lead to some period of consolidation.

P2P platforms are operationally geared to new loan originations. For instance, 90% of

LendingClub’s (NYSE:LC) 2015 revenues of $427m came from deal fees, with only 10%

generated from recurring income.

Negative publicity, say if a large UK P2P operator become the victim of fraud/malpractice

– thus potentially damaging the good name and future prospects of the industry as a

whole.

Possible pull back of institutional money, say in the event of a recession.

Despite being FCA-regulated, P2P lending is not covered by the Financial Services

Compensation Scheme, as is the case for consumer (but not corporate) deposits of up to

£75,000.

Impact of an economic downturn, and subsequent knock-on effect wrt NPLs.

ArchOver, being a niche player, is relatively small and could get squeezed by larger rivals.

P2P exchanges handle financial transactions, so there is an inherent risk from cybercrime,

hacking and/or web attacks.

ArchOver is still pre-profitability and executing on many fronts - hence it is important

that sufficient resources continue to be made available to fund its rapid expansion.

Head of Corporate

Gilbert Ellacombe Direct: 0207 065 2698 Tel: 0207 065 2690

[email protected]

Investor Access

Hannah Crowe Ben Ferguson Direct: 0207 065 2692 Direct: 0207 065 2693 Tel: 0207 065 2690 Tel: 0207 065 2690

[email protected] [email protected]

This report is intended for

Professional Clients, Self-certified High Net Worth or Sophisticated Investors only.

Equity Development is regulated by the Financial Conduct Authority

Equity Development Limited (‘ED’) is retained to act as financial adviser for various clients, some or all of whom may now or in

the future have an interest in the contents of this document and/or in the Company. In the preparation of this report ED has

taken professional efforts to ensure that the facts stated herein are clear, fair and not misleading, but make no guarantee as

to the accuracy or completeness of the information or opinions contained herein.

This document has not been approved for the purposes of Section 21(2) of the Financial Services & Markets Act 2000 of the

United Kingdom (‘FSMA’). Any person who is not a relevant person under this section should not act or rely on this document

or any of its contents. Research on its client companies produced and distributed by ED is normally commissioned and paid for

by those companies themselves (‘issuer financed research’) and as such is not deemed to be independent, as defined by the

FCA, but is ‘objective’ in that the authors are stating their own opinions. This document is prepared for clients under UK law.

In the UK, companies quoted on AIM are subject to lighter due diligence than shares quoted on the main market and are

therefore more likely to carry a higher degree of risk than main market companies.

This report is being provided to relevant persons by ED to provide background information about the subject matter of the note.

This document does not constitute, nor form part of, and should not be construed as, any offer for sale or purchase of (or

solicitation of, or invitation to make any offer to buy or sell) any Securities (which may rise and fall in value). Nor shall it, or

any part of it, form the basis of, or be relied on in connection with, any contract or commitment whatsoever. Self certification

by investors can be completed free of charge at www.fisma.org

ED may in the future provide, or may have in the past provided, investment banking services to the Company. ED, its Directors

or persons connected may have in the future, or have had in the past, a material investment in the Company. Brian Basham,

Chairman of ED, was one of the founders of ArchOver.

More information is available on our website www.equitydevelopment.co.uk

Equity Development, 15 Eldon Street, London, EC2M 7LD. Contact: [email protected] 0207 065 2690

http://www.equitydevelopment.co.uk/

mailto:[email protected]

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