Credit Risk Assessment

Abundance offers two types of direct investment: debentures (a form of bonds) issued by UK companies; and, loans offered by councils (local authorities). As loans and debentures are regulated differently by the Financial Conduct Authority, Abundance’s role also differs when you are investing in a company debenture compared to a council loan.

In the case of loans, our Investments Team completes a Credit Risk Assessment to consider the risk that a council borrower will not be able to meet the payments due under the loan before Abundance arranges such a loan.

Assessing a council

We only arrange loans for UK local authorities (“councils”) currently. We aim to provide a competitive source of capital to councils, thereby supporting them in their efforts to deliver front line services with value for money, while at the same time enabling them to build a more engaged and transparent relationship with their residents and people elsewhere in the UK through the act of becoming citizen lenders.

As public bodies, and given the range of essential services they provide to residents across the UK, the functioning of councils is heavily regulated including their ability to borrow. Councils have a statutory power to borrow, but must do so in accordance with the Prudential Code for Capital Finance in Local Authorities (“Prudential Code”) and the Ministry for Housing, Communities and Local Government Guidance on Investment (“MHCLG Guidance”). The main requirement for these rules and regulations is that borrowing supports prudent management of the council’s finances and / or is for long-term capital projects. The councils must demonstrate that the borrowing is affordable, sustainable and prudent.

When borrowing money through Abundance, a council will typically be raising the money for a specific purpose(s) or project(s) and will set this out in the Offer Document, however you will be lending money to the council as a whole. That means the risk of your investment is not directly linked to the specific purpose or project itself and is instead linked to the wider strength of the council.

We will only arrange a loan for a council when we are satisfied that the council has followed the correct process for authorising the borrowing and that the borrowing is both legal and within the council’s prudential borrowing limits. This assessment includes asking a council a set of questions to confirm they have met their legal requirements for borrowing through the loan, and also have not recently been in financial difficulty.

This includes confirmations that:

  • The borrowing is within the council’s legal authority;
  • The council has not issued a Section 114* notice in the last 3 years; and,
  • The council’s cash reserves are above the minimum set by the council and not expected to fall below this level within the next year.

*If a financial officer sees that a council is going to fail to keep a balanced budget it must issue a notice known as a Section 114 Notice. By issuing a Section 114 Notice the council’s chief financial officer takes full control of council spending and will typically immediately freeze all non-statutory spending and look to make rapid cuts in order to return the council to a balanced budget. The Local Government Act 2003 also has provisions to enable central government to take direct control of the running of an authority if it fails to return to a balanced budget.

The purpose of this credit assessment is to ensure that the council meets the eligibility criteria for offering a loan on Abundance and that they meet the requirements for our council risk category. We should be clear that this assessment does not mitigate the risk of investing in a council loan and should a council run into financial difficulties it may not be able to meet its payment to you as the lender.

Risk categories

Due to the nature of councils and the legal restrictions in place to regulate a council’s finances and borrowing levels, the risk of lending money to a particular council is broadly similar to the risk to lending to any other council. In addition, as part of our credit assessment we do not arrange loans for councils that are in current financial difficulty or have been recently.

We therefore have a single risk category for all loans arranged with UK councils and the price of any loan will be determined by our pricing policy below.

Pricing

The price of a particular council loan, which is the interest rate the council borrower pays and the rate you would receive as the lender, is set by Abundance at the start of the loan and is fixed for the duration of that loan. We must ensure that the price of the loan is fair and appropriate and reflects the risk of lending to a council.

Councils typically have a range of sources when considering borrowing money. The main source of borrowing for councils is from UK central Government through the Public Works Loan Board (“PWLB”) which provides loans to councils at a rate that is linked to the cost of borrowing for the UK Government (through gilts in the financial markets).

The interest rate set for a council loan on Abundance is linked to the current PWLB rate. This means that each council loan on Abundance will have a different rate linked to the wider cost of borrowing for councils and UK Government at the time the loans were arranged. So, over time, should the interest rate on UK Government Gilts increases, the PWLB rates that councils can borrow at will also increase, and so the interest rate on a new council loan on Abundance would also increase. The interest rate on a council loan will be derived from the relevant PWLB rate shortly before the loan is arranged. The PWLB Standard Rate is updated twice a day and priced at the current rate on a Gilt plus 100 basis points (in some circumstances councils can also borrow through the PWLB at lower rates). You can find the latest PWLB pricing here.

Abundance charges a council an upfront set up fee for arranging a loan. As well as the current PWLB rate, the interest rate on a council loan will take into account Abundance’s arrangement fee amortised over the term of the loan and any ongoing management fees such that the overall cost to the council of the loan plus our fee is broadly equivalent to the PWLB rate. However, as our fee is paid separately to the interest on the loan, the interest rate paid by the council is the same as the rate you will receive as the lender of the loan.

Loan status and default

Abundance monitors the performance of each loan over its term to check the council borrower makes its loan payments on time. Over the life of a loan a council may run into difficulties and fail to meet the terms of the loan - for instance failing to make a capital or interest payment as scheduled. Abundance’s process prioritises the interests of lenders and aims to create a transparent process so that, in the case where a council borrower has been unable to comply with the terms of the loan agreement, lenders can be confident that their interests are being looked after.

Lenders can see the current status of a loan in their Abundance account, as well as any updates posted against the loan related to the current status.

The following outlines the different potential statuses of a loan, and the circumstances in which a loan will be classified as such:

  • On track: This is where a council loan is performing as expected and all payments under the loan have been met.
  • Late Payment: This is where a council has not made a payment due under the loan terms. A loan will be classified as Late Payment on the next working day after the payment was due. In these circumstances Abundance will be in contact with the council to understand the reasons for the delayed payment and provide an update for investors. In most cases a late payment may simply be due to a banking or other administrative delay. We may choose to suspend trading of a loan through the marketplace when a loan has a late payment.
  • In Default: If a loan payment remains overdue after 10 days, the loan is classified as In Default. Also, a loan will also be classified as In Default if a council is unable to meet any other obligation of the loan (other than payment) and this is not remedied within 20 days. Where a loan is In Default, depending on the reasons for the default and our expectation for the council resolving the breach of terms, we may issue the council with a demand for repayment of the loan in full. Abundance will form a recovery plan and take enforcement action against the council to recover value for borrowers. The loan will be suspended from trading on the marketplace once In Default.

It should be noted that unlike a corporate entity, a council cannot declare bankruptcy as a way of avoiding the debt liability. You can read more about what happens when a council runs into financial difficulties here.

Loan Performance

When you invest in council loans on Abundance there is always a possibility that some of them will be unable to meet their obligations to investors and you could lose some or all of your original investment. We publish the performance of the loans offered through Abundance on an annual basis and compare this to the expected performance for the loans. Performance is shown in terms of the percentage of loans offered through Abundance that have been placed into Default.

Expected default rate

Abundance offers only one risk category of loans offered by councils. Due to the nature of councils and how they are legally structured, it is technically not possible for a council to become bankrupt and avoid its debt obligations. However, it is possible that they could run into financial difficulties, in the sense that their revenues do not cover their expenditure, which may prevent or delay payment of your interest and capital on an investment.

Over the last 20 years, only 2 councils have issued a Section 114 Notice, with the most recent being Northamptonshire County Council in 2018. A Section 114 Notice is issued when a council believes it will be unable to keep a balanced budget. However, in such circumstances it does not mean a council will necessarily default on its debt as it is the council’s chief financial officer’s duty to take full control of council spending and typically immediately freeze all non-statutory spending and look to make rapid cuts in order to return the council to a balanced budget.

To our knowledge, no council has defaulted on an interest payment on a simple loan resulting in a loss for the lender. Our expected default rate for council loans arranged on Abundance in 2021 is therefore 0%.

While our current expectation is that there is a very low chance of a council defaulting on its loan obligations, this does not mean that it is not possible and there are risks when investing in a council loan. Past performance is not a guide to future performance and you should make sure you understand the risks before investing. Given the long-term and illiquid nature of the loans, you should not invest money that you may need to access quickly if your circumstances change. Although the loans have a low risk of default, it is not the same as depositing money in a savings account for example.

Actual default rate

Abundance reports the actual default rate of loans arranged on Abundance within 4 months of the end of its financial year.

As the first loan arranged by Abundance was in 2021, our first reporting period will be for the calendar year 2021 and will be published in early 2022.