The financial services sector often conjures images of expensively suited handshakes in steel-and-glass skyscrapers. But the provision of credit happens everywhere, from the boardroom to the doorstep. Like retail, it is a broad field.
In the past decade, the ways lending and borrowing both look and occur have changed markedly, particularly when it comes to high-cost consumer finance. As the largest high-street lenders have withdrawn from many product lines, and digitisation has slowly extended its reach, we have seen the rise (and fall) of payday loans companies, and the steady march (and stutters) of listed credit providers Provident Financial (PFG), Non-Standard Finance (NSF) and Morses Club (MCL) – who variously operate under the banners of ‘sub-prime’, ‘near-prime’ or ‘non-standard’ lending.
Last year, the clique expanded with the initial public offering of Amigo Holdings (AMGO), parent company of guarantor lender Amigo Loans. The early market reaction was sanguine. But shares in the group – which lends to individuals with a creditworthy friend or relative prepared to act as a backstop – cratered at the end of August fter a miserable trading update appeared to anticipate a Financial Conduct Authority crackdown.
For investor confidence in a freshly minted FTSE 250 constituent to be so thoroughly shaken in such a short timeframe would normally come as a shock. But it is symptomatic of a high-risk corner of the market locked in an unending game of cat-and-mouse with its regulator. A regulator, it should be mentioned, that has identified “significant harm to consumers using high-cost credit, many of whom are vulnerable”.
In relative terms at least, the Financial Conduct Authority’s (FCA) wide-ranging programme of sector reforms, emboldened by the success of a 2015 cap on payday lenders, has arguably had a greater sectoral impact than enhanced capital rules on the banks. What’s more, the tenor of intervention does not appear to be softening.
High risk, high returns?
The pitch from providers of high-cost debt – and thus central to investment cases of the listed companies above – is that mainstream lenders have abandoned millions of potential borrowers, who are now cut off from vital sources of short- and medium-term capital and trapped by poor credit ratings. Executives of these companies speak proudly about bridging this gap, and helping borrowers to improve their credit scores – even if the logical extension of this view would mean the destruction of their asset and customer bases.
But to UK shareholders, the sector’s main attraction has been its historically high return on assets, at least relative to mainstream lenders. One notable backer has been famed stockpicker Neil Woodford, whose investment management group has built large positions in Provident, NSF, Amigo and Morses Club.
The sector’s attractions
| Morses Club | LoansatHome | NSF group | Everyday Loans | NSF (Guarantor) | Amigo |
Year-end | Feb-19 | Dec-18 | Dec-18 | Dec-18 | Dec-18 | Mar-19 |
Revenue yield | 168.8% | 171.5% | 60.2% | 46.5% | 32.2% | 41.3% |
Cost of risk | 37.8% | 55.9% | 15.5% | 10.1% | 5.2% | 9.8% |
Risk-adjusted yield | 131.0% | 115.6% | 44.8% | 36.5% | 26.9% | 31.5% |
Impairment rate | 22.4% | 32.6% | 25.7% | 21.6% | 20.0% | 23.7% |
ROA | 31.6% | 17.7% | 13.0% | 15.8% | 11.3% | 24.3% |
ROA after financing | 29.1% | 11.2% | 5.4% | 8.3% | 2.7% | 17.5% |
Source: Company accounts, Peel Hunt | ||||||
In the case of his biggest bet on the sector – Provident Financial – Mr Woodford could also point to one source of optimism: the 139-year-old group had a pretty good financial crisis. However, this abruptly came undone in 2017, when an ill-advised attempt to change its home collection strategy caused collections and sales to drop, leading to massive impairments. Compounding this, the FCA launched a probe into the sale of repayment option plans by its credit card subsidiary, Vanquis Bank.
Two years, one rights issue, several leadership changes and one failed hostile takeover attempt by upstart Non-Standard Finance later, and the group is yet to emerge from the woods. While half-year results saw a strong increase in adjusted profits at sub-prime car finance arm Moneybarn, alongside the re-instatement of the half-year dividend, efforts to turn around Vanquis – described by management as the “fulcrum of the group” – remain a battle.
Among the doubters are analysts at Canaccord Genuity, who view impairment risk as “a real concern”. In a sell note published last month, the brokerage argued that impairments could rise given our current position in the credit cycle, together with the possibility that around 15 per cent of Vanquis credit card customers could soon be classed as being in “persistent debt” by the FCA. In turn, reckons Canaccord, this could see thousands of customers move to payment arrangement plans, thereby placing greater strain on Provident’s efforts to invest in (and scale up) one promising revenue stream: a hybrid remote credit product.
High regulation
Though few would dispute the need for repeated reviews of the sector’s impact on borrowers, it can be hard for high-cost credit providers to plan with much confidence. The changes facing credit card borrowers locked in persistent debt mentioned above are just one set in a raft of FCA-designed rules washing through the system.
By March 2020, lenders will also have to comply with stricter affordability testing. That follows the introduction of new rules earlier this year, brought in after the FCA found some forms of refinancing in the home-collected credit market were costlier than new loans, to ensure that “any discussion on repeat borrowing in the home is consumer-led, and helps consumers fully understand their options”.
Pressure from civil society and anti-debt campaigners, as Amigo has fast come to realise, is one area of corporate Britain where industry might be outnumbered. And even if the demand for unsecured lending continues to rise each year, there is little political capital in defending a sector where an annualised interest rate of40 per cent is considered reasonable.
That pressure is unlikely to dim. The Citizens Advice Bureau, which advised 350,000 people on their debts last year, continues to petition the FCA to extend the payday loan cap to the doorstep lending markets. And that’s without high-cost credit even on the mainstream political agenda. For those brave enough to see what that can look like, they need only look at the share price of Provident’s international offshoot, International Personal Finance (IPF).
