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Claims surge rocks Provident Financial

A calamitous trading update again highlights the perils of investing in sub-prime lending
March 15, 2021
  • Surge in claims threatens solvency of consumer credit division
  • Doorstep lender faces fresh investigation from the watchdog

In an unscheduled trading update this morning, Provident Financial (PFG) said fourth-quarter results for 2020 will likely come in ahead of analyst forecasts.

What was far from market expectations, however, was news that the sub-prime lender intends to enter its consumer credit division (CCD) into a Scheme of Arrangement, following a surge in customer complaints.

Management says the scheme will allow it to distribute £50m set aside in redress for what it describes as legitimate customer claims, a process that will incur additional operating costs of £15m. However, the Financial Conduct Authority (FCA) has objected to the scheme in its present form, arguing creditors could receive less than the full value of their claims. 

Should the regulator shoot down the plans in a court hearing in April, Provident says the division will likely “be placed into administration or liquidation”, leaving all customer complaints unfunded. A scheme of arrangement is a temporary, court-approved measure that helps a company restructure its capital, assets or liabilities. 

The effect of this on credit card division Vanquis Bank and sub-prime auto loans arm Moneybarn “would not be significant”, says management, while acknowledging that relationships with customers, suppliers and regulators could be damaged from the episode.

Relations with the latter already appear strained. In addition to news of the possible administration, Provident revealed that the FCA has opened an investigation into the affordability and sustainability of the CCD’s lending and claims handling practices in the year to February. While no rule breaches have so far been determined, the news that the review is likely to drag on until 2022 compounds the headache for investors.

The CCD, which serves hundreds of thousands of customers through the Provvy’s traditional doorstep lending arm and the online-only Satsuma Loans, was on course to break even “on a monthly basis” before Covid-19 struck last year.

But a spike in impairments was followed by a sharp increase in complaints across the home credit market, fuelled by what management characterise as heightened claims management company activity. This resulted in £25m in payments to customers in the second half of the year, while a further £11m in balance reductions has added to the bill.

In echoes of 2017 – when a revamp of the consumer credit division backfired badly and precipitated a dilutive rights issue – shares in the FTSE 250 group fell 30 per cent on this news to 184p, as investors weighed up the prospect of spending the coming months placed in a regulatory headlock.

The lesson from guarantor lending group Amigo (AMGO) which, like Provident, has pursued a Scheme of Arrangement after witnessing a surge in ombudsman-backed customer complaints and successful claims, is that high-cost credit’s promises of outsized internal rates of return must be checked against a higher risk of external shock.

Although the sector’s claims to serve under-represented customer groups are not entirely without foundation, high-interest lending quite rightly comes with greater regulatory and political scrutiny. We have long argued that investors have little choice but to accept this, and even invite the oversight.

They should also apply big discounts to sector book values and a big pinch of salt to analysts’ earnings forecasts – which for Provident stand at 10.9p per share for the current financial year. Hold/avoid.

Last IC View: Hold, 222p, 26 Aug 2020