Crowdcube Introduce a Probability of Default Rating

A report by the Secret Investor

Crowd funding website Crowdcube are providing additional information to those considering investing in the platform's mini-bond offerings in the form of a Probability of Default (POD) Rating which is calculated using Moody's private company risk model.

The POD provides an indication of creditworthiness and is based on the past performance of the borrower. Although Crowdcube allows equity to be bought in start-up companies, only well established businesses can raise funds via mini-bonds on the site. Their longevity provides a track-record from which a POD can be calculated.

Mini-bonds are a vehicle used by larger companies for raising capital. For investors they provide a regular income over 4 or 5 years with their initial sum being paid back when the bond reaches maturity. On Crowdcube returns of between 6% and 8% pa are available.

The first two companies to have a POD rating included on their mini-bond propositions are Vanarama and Square Pie who are van rental and gourmet food operations respectively. They have impressively low POD ratings of 0.7% and 0.5% which compares well with the 3.3% average that has been retrospectively calculated for mini-bonds which were previously listed on the site.

Despite the POD calculations indicating these investments are much lower risk than typically was the case for previous mini-bonds both are offering interest rates of 8% pa which is the top return the site offers for this type of investment – this implies a contradictory higher level of risk.

But Crowdcube emphasise that the POD rating should not be viewed in isolation as the process that generates it is solely based on historical statistics. The most important consideration for lenders is what does the future hold? Will the company be able to cover the interest payments and pay back the capital at the end of the agreement in 4 or 5 years?

Possibly there were many other factors which resulted in Crowdcube allocating the first two organisations to receive a POD value with the highest possible interest rate. For one thing, both could be vulnerable in an economic downturn. The van rental market is liable to dip if there was less commerce taking place and gourmet food would be replaced in shopping baskets by cheaper alternatives if household budgets were tightened.

There are questions as to whether these mini-bonds provide the best risk/return ratio in relation to the wider alternative finance market. Essentially, these are unsecured medium term interest only loans and, elsewhere, higher returns than the 8% pa maximum of Crowdcube are available for interest only loans with capital secured via a guarantor, property or other assets. While the borrowers are less well established operations in those cases, investors can often receive 50% more income.

Another issue to consider with the Crowdcube mini-bonds is the minimum investment is quite a substantial £500. Even if this represents a small percentage of your portfolio, other sites allow individuals to contribute as little as £20 to the totals lent enabling risks to be spread more widely.

Nonetheless, these mini-bonds provide the opportunity to invest in large companies while receiving a reasonable, predictable – but not guaranteed – rate of return which is more than can be said for the stock market at the moment. The POD provides a measure of historical performance when deciding whether to allocate capital in this area.