Systems risk

Conduct risk

The group's overall risk management programme focuses on reducing the effect of these risks on its financial performance. A risk appetite (the level at which risk is accepted by the group before action needs to be taken) is established for the key risk areas. A regular assessment of the principal risks affecting the group, based on a traffic light classification, is carried out by the executive directors who then pass this on to the full board of directors. The board identifies, evaluates and mitigates financial risks and there are written policies for all major risk areas at subsidiary company level (where the activity takes place). The tables above show the group's principal risk appetite and how risk is mitigated. A risk register is maintained in which any instances of any of the aforementioned risks are recorded and, where necessary, acted upon.

We are committed to maintaining the highest standards of ethics and integrity in the way we do business. We adopt a zero tolerance approach to bribery and fraud and expect our business partners to do the same. Our staff are encouraged to contact the board if they have any concerns in this regard. We are committed to behaviour that results in fair outcomes for our customers (both introducers and end borrowers).

In summary:

·      credit risk is reduced by a robust system of checks on introducers, borrowers and by third party guarantees;

·      liquidity risk is alleviated by borrowing facilities from our funders;

·      interest rate risk is mitigated by the fact that most loans are short term and by regular interaction with our bankers;

·      risk from disruption to the IT system and cyber-crime is avoided by thorough business continuity procedures and procedures designed to prevent, detect, respond and recover from malicious attacks; and

·      conduct risk is mitigated by staff training, board oversight and monitoring of introducing partners.

The nature of the business is that loans are made either to finance companies or to clients of our introducing partners. Although there is some significant lending to individual finance companies, the underlying debts making up these loans are collected by Orchard and assigned to Orchard. At 30 September 2021, the latest date of review, the largest nominal exposure was £3.82m to one finance company representing 12.48% of our loans (before expected credit loss provisions).  The highest exposure to a non-finance company was £2.43m and consisted of advances comprising many smaller loans (the average amount for each loan was £178). The reality, therefore, is that our exposure is low. At 30 September 2021 total outstanding loans were £30.60m (at 31 July 2020 £27.52m) (before expected credit loss provisions), of which the highest individual loan (not a block loan to a premium finance company) was £26.80k. This was for asset finance and represented less than 0.1% of total outstanding loans. This is likely to remain the situation in the future.

We have experienced late payments in the past. The majority of these are through our customers changing banking details. Prior to the year to July 2020, we made a charge for late payments. This reduced our expected credit losses. Last year and this we have not made these charges. We intend to do so again in the next financial year.

During this year, because of COVID-19, some of our borrowers requested payment holidays and we have accommodated these. Where they are properly agreed with a borrower, these payment holidays do not necessarily result in a significant increase in the credit risk associated with those loans. The "days past due" for these loans is based on the revised, agreed schedule. That is not to say that there may be other factors which might impact on credit risk but these are looked at separately as part of our wider review of the credit quality of our lending.

We review debts for impairment and make provision where necessary. As part of this process, we have released £131k during the year to 31 July 2021, net of reversal of previous provisions and items written off against those provisions (£130k was charged in the year to 31 July 2020). The provision this year is £72k carried forward at 31 July 2021 (£217k at 31 July 2020). Part of the reason for this reversal is that, where we are not paying out cash until months later, these have been excluded from need to make provision as there can be no credit loss on these. Note 2.6 on page 40 of the full financial statements outlines the approach to credit impairments.

There is no doubt that the level of potential bad debt  had been adversely affected by COVID-19 for most of the year, The biggest consequence of COVID-19 had been cancellations of loans taken out to pay for discretionary spending. This did not lead to financial losses but reduced lending (and therefore income) below the level we had projected in the year before last. The latter part of the year has seen lending starting to increase again.

The main uncertainties in these financial statements are those connected with the level of expected credit losses. Although objective evidence is obtained where possible (macroeconomic factors etc.), these still require a good deal of management judgement. They are detailed in note 3 on page 45 of the full financial statements.

The business environment

COVID-19  was identified as a pandemic in March 2020 by the World Health Organisation and our Government took action to control its spread in this country which resulted in the closing of many businesses in that month. We suffered in the period up to 31 July 2020. Our financial year began in the same vein. There was an easing of lockdown in July 2020 but this quickly led to further out-breaks of the disease resulting in a full lockdown by January 2021. This has effectively remained through most of the rest of the group's 2020/21 financial year. However, Orchard has seen increases in lending towards the end of the financial year and our forecasts indicate that this is likely to continue. This will, of course, be dependent on the economy remaining open.

One outcome of the restrictions was that Government debt replaced non-mortgage, personal debt. A research publication by the Commons Library published in July 21, quotes figures from the Bank of England showing that unsecured debt fell in each month between March 2020 and May 2021.

This, again, impacted our lending in that individuals who might in the past have financed insurance premiums etc. were not borrowing to do so.

We now have a trade agreement with the EU, although there is uncertainty attaching to the Northern Ireland Protocol. The board is of the opinion that the direct effect of this on Orchard will not be significant in the short to medium term. There are too many unknown factors to assess the situation in the longer term. The main issues are still likely to revolve around the value of the pound against other traded currencies, which will impact on spending.

Development and performance of the business

Overview

The financial year began for us in the same vein as the year before had ended, with reductions in lending in every month when compared to the equivalent month in the previous year.

This situation continued until March 2021 after which lending began to rise again on the same basis. We still believe that most of our premium finance growth will come from the direct insurance side rather than from broker premium funding companies, although these companies still remain our largest market. The demand for professional fee finance has continued to slow.

Product lines already introduced are reviewed regularly to evaluate the impact they are having on the business. To date that impact has been encouraging. We continue to use the same disciplined approach when evaluating potential new markets.

We began lending into longer term markets, as mentioned last year and these are going well. We intend to grow these  further. Details are shown in future developments on page 13 of the full financial statements.

To summarise: it remains our intention to increase our sales in existing markets, expand into adjacent markets, maintain good cost control commensurate with our plans and secure further sources of funding.

Financial indicators

The function of the business is to lend money safely. The ability to find borrowers is therefore key to the business. We have not only added to our introducing partner base but have begun again to sell more through this base. This continues to work well (albeit that economic conditions have become more challenging this year).

Our margin is an important area. Some of our borrowing is fixed to bank base rate and some to SONIA. As these rates alter so will our borrowing costs. Given the short term nature of most of our lending any likely changes would make a small impression on margins. Our own analysis indicates that the influence on our business would be negligible and it is for this reason that our risk appetite is to accept rate increase of up to 25% higher than we are paying at the time the loan is made to a customer (see Interest rate risk on page 7 of the full financial statements). Rates for new lending can, however, be altered to reflect any changes. There is, however, greater risk with our longer term products that rate increases would erode margins.

Other operating costs in this business are relatively stable. We have increases resulting from an increased sales function, staff costs and enhancements to our IT systems but other overheads have been reduced. The net result is an overall increase of 3.28% (excluding provision for expected credit losses). 

Financial key performance indicators (KPIs)

The table below gives a breakdown of group KPIs as well as indicators not considered KPIs but which give a better understanding of the figures.

Lending, revenue and profit are all lower than last year. During 2020 COVID impacted our business for approximately four months. This year the impact was for eight months. Given the circumstances, the directors are satisfied with the performance of the group.

As would be expected, this decrease in lending has led to a decrease in profitability.

KPIs

Other performance indicators

1.     Average interest earning assets consist of the average of the opening and closing loan book after taking account of the impairment provision.

2.     There are no factors which would dilute earnings therefore fully diluted earnings per share are identical.

3.     Dividends per share are based on interim dividends paid in the year and proposed final dividend for the year.

Net total income (as shown in the Consolidated income statement) was lower than the previous year, mainly as a result of reduced lending. Operating costs overall are up by £80k. Included in operating costs is commission paid on direct insurance business and this business has increased this year leading to higher commission costs of approximately £83k than in 2020. Additionally, staff costs were £89k higher. Other operating costs have seen reductions of £92k. In all, the board are happy with the operating costs in the business.

Non-financial indicators

Staffing

The most important non-financial indicator remains quality of management and staff.

Our senior members of staff are all fully trained in every facet of the business and have good relationships with more junior staff members whom they able and willing to assist when required. They have been with us for many years.

Customer care is of paramount importance in our business culture and this aspect is a constant part of training for everyone in the organisation. Feedback from our partners in this area has been very positive. Non-financial performance targets set for our staff have all been met. These include, but are not limited to, ensuring that our partners and end-user customers receive prompt responses to any queries they raise.

Orchard is a small group with 16 non-director employees. Although no employee is on the main board, there is no formal workforce advisory panel, nor is there a designated workforce non-executive director, all employees have access to the executive directors at any time and can raise any issues with them. They are also able to contact the Chairman should they wish to discuss a matter which they feel may not be appropriate for the executive.

Partner retention

Partner retention is another significant area in our business. This couples well with another non-financial indicator, brand preference. As our partner base grows, so does awareness of who we are and what we do. We review our partner base regularly to establish whether they are increasing or decreasing the amount of business they do with us. Action is taken if business from one source is dropping.

Innovation

A key non-financial strategy is innovation (see Strategy and objectives on page 5 of the full financial statements). Innovation is the ability to continually evolve and grow our business in our chosen markets. When looking at new products we stay within our risk parameters and examine whether the returns justify the resources expended. If new products fit our return and risk expectations, we proceed to the testing stage - relatively small amounts of lending. We believe that innovation is fundamental to growth.

IT systems

A robust, reliable and secure IT system is crucial to the business. We work closely with external outsource partners to continually review and develop our IT systems. We completed the initial development of our system and it is now the only system we use. Our customers have seen advantages of this, making it easier to manage their agreements. We continue to upgrade the system in response to customer requirements.

Quality of lending

Our lending has been based on sound underwriting since we began - we carefully assess any person or body to whom we lend. In addition, we receive at least one instalment before we pay out (eliminating first payment default); the direct debit establishes timely collection and an electronic link to our borrowers; in most cases our partners guarantee the payment should the end borrower default; and, if the partner fails, many of our end borrowers are protected by the financial services compensation scheme thereby ensuring that we are paid.

Good governance

The role of the board is set out in the Corporate governance report on pages 21 to 23 of the full financial statements. Among its objectives is to protect and enhance long-term value for all stakeholders. It sets the overall strategy for the group and supervises executive management. It also ensures that good corporate governance policies and practices are implemented within the group. In the course of discharging its duties, the board acts in good faith, with due diligence and care, and in the best interests of the group and its shareholders.

Going concern

The financial statements have been prepared on a going concern basis which assumes that the group will be able to continue its operations for the foreseeable future.

The directors continually assess the prospects of the group. Forecasts are prepared for a four year period, on a rolling basis. These are also subject to stress testing, the main aspects of which are the value of loans made, the return on those loans and the level of expected credit losses. In these scenarios, there is no indication that there will be a problem in continuing as a going concern, even taking account of the effects of COVID-19. However, it is important to appreciate that the further away in time the estimate, the less reliable it is. Our forecasts assume a base rate of 0.10% in the short term, although if this increased further there would be little impact because of the short term nature of most of our lending.

The character of our lending is such as to permit us to react to any changes in base rate within a short period of time (as mentioned in the section on interest rate risk earlier in this report) and with relatively little impact on our margins.

As a result of our estimate of the impact of the post COVID-19 economy, we continue to be cautious in our forecasting.

The key assumptions and bases used in the forecasts are now:

·    Loans through our partners will grow to circa £77m in 2023/24;

·    Liquidity will be available to fund those loans;

·    Margins on lending will remain relatively stable throughout the period averaging at 6.08%;

·    Overheads will increase at the rate of inflation with stepped increases at certain points, e.g. when capacity constraints are hit or when project spending is required;

·    The funding system will be able to accommodate the increased business.

The directors have prepared and reviewed the financial projections covering a period of almost four years from the date of signing of these financial statements. In each year, and in particular in the 12 to 18 month period from signing, there is sufficient cash and there are sufficient reserves to enable the group to pay its debts as they fall due. In addition, they have further stress tested these projections to a point which they believe is unlikely to happen  (reducing lending, reducing margins and increasing bad debt) to give a confidence buffer. Even in this scenario, based on the level of existing cash, the projected income and expenditure and the excess of our loan book over external debt, the directors have a reasonable expectation that the company and group have adequate resources to continue in business for the foreseeable future. Accordingly, the going concern basis has been used in preparing the financial statements.

Future developments

It is the intention of the board to continue and grow our core markets. In addition, we tested a small amount of longer term asset lending (static caravans as we mentioned last year) and this seems to be working well. It is our intention to expand this but only if our underwriting procedures indicate that it is advantageous for us to do so. The lending will be fully secured by the introducers. As mentioned before, given the longer term nature, a more vigorous approach is taken to lending in this area.

We shall, of course, continue to look at other markets which fit our risk and return profile. The board has agreed to a pilot test of bridging finance. This will be short term (less than a year) and, as usual, subject to our rigorous underwriting procedures.

The group will continue to look at alternative sources of finance as liquidity is of key importance to what we do.

Environmental, social responsibility, community, human rights issues and gender diversity

The impact of the group on the environment consists of power used in an office environment and fuel used for getting to and from work. Environmental issues are therefore negligible (see SECR reporting later on in this report).

The group operates out of an office in Luton. Most of our employees are based in the local area. We therefore contribute to the economy of the local community and keep our travel carbon footprint relatively low. We provide health club membership and childcare vouchers for any staff who wish it.

We provide equal opportunities for all applicants and members of staff, irrespective of race, colour, sex, disability or marital status.

The composition of the main board of directors is currently all male. The board of the two subsidiaries consist of one male and two females each. Males make up 68.42% of the employees in total (68.18% in 2020).

We review the background of our suppliers and will not use any supplier which, as far as we are aware, breaches our own high standards as regards human rights.

Section 172(1) Statement

Section 172(1) requires a director of a company to act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard to:

(a) the likely consequences of any decision in the long term,

(b) the interests of the company's employees,

(c) the need to foster the company's business relationships with suppliers, customers and others,

(d) the impact of the company's operations on the community and the environment,

(e) the desirability of the company maintaining a reputation for high standards of business conduct, and

(f) the need to act fairly as between members of the company.

All matters brought to the board for consideration are reviewed in the light of how they will impact on stakeholders. This review involves balancing the interests of all stakeholders and includes having regard to:

·    profitability;

·    risk associated with the proposal (see Principal risks and uncertainties);

·    how the decision will impact on our employees (both in financial terms and how the quality of their work life and outside life will be affected). Further detail on how we engage with our workforce is shown under Environmental, social responsibility, community, human rights issues and gender diversity;

·    what impact it will have on our partners and other customers (as  mentioned under Non-financial indicators). Proper customer care, particularly in avoiding unfair outcomes, is of paramount importance to Orchard;

·    our reputation (the impact of loss of reputation is dealt with under Conduct risk);

·    either the CEO and/or CFO meet with major investors at least twice a year (albeit by Zoom in the last 18 months) to discuss the group's progress and overall plans, obtaining valuable comments on how we are perceived. All reports and other documents are on our website and any investor may request a meeting with any member of the board.

In a wider sense:

·    Orchard does not deal unfairly with its suppliers and business associates and ensures that payment terms are adhered to. In fact, in many cases it assists those associates to expand their business. For example, we have increased our investment in Open B Gateway Limited, a small private company, so that they could have the benefit of finance to further develop their software platform;

·    it behaves as a good neighbour, helping the local community where it is able and employing people from the locality - which also assists in reducing our carbon footprint; 

·    in its dealings with government, particularly the revenue authorities, it is completely open, paying what it owes on time;

·    it has had no instances from the FCA of non-compliance with regulations;

·    Environmental, social responsibility, community, human rights issues and gender diversity are discussed earlier.

The board considers whether proposals put to it have long-term outcomes which affect its stakeholders. In most cases the proposals have no material long-term consequences. However, where there are potential consequences, the board takes account of the long-term nature of its decisions. For example, some years ago decisions were made both to change our IT system and to apply for a banking licence. Both decisions were long term in nature and required resources to be provided. The board agreed to both, seeing the benefits in the longer term for most of our stakeholders. During the year it was decided to withdraw the application for the banking licence.

In deciding on the pilot for bridging finance during the year as noted on page 13 of the full financial statements, the board took account of the requirements of 172(1).

Streamlined Energy and Carbon Reporting (SECR)

The directors believe that the company is exempt from reporting under the SECR framework as its energy use is below the threshold for reporting. The de minimis exemption is for companies whose usage is below 40MWh in the reporting period. According to CLS Chartered Consultancy this is the equivalent of around nine houses worth of electricity or four houses worth of gas. The group operates out of a small office which operates only on electricity and has had no more than two staff members working there during the year. Fuel for cars is provided for some staff but the total amount of fuel used is no more than 8k litres.

Approved by the directors and signed by order of the board

Liam McShane,

Company secretary

25 October 2021