Buy Provident Financial's recovery potential

The calamity that ensued when management decided to reorganise Provident Financial's home credit business torpedoed pre-tax profits last year and the balance sheet. Customer collections and sales nosedived when self-employed agents were replaced with full-time employees, which was partly because software used to schedule collections was chucking out inaccurate data. However, following a management overhaul, this business has been gradually improving its performance, which is being reflected in a rebound in collections. During the first quarter of this year, the headline collections performance was 70 per cent, up from 57 per cent in August 2017 and 65 per cent in September. That’s against an historically more normal rate of 90 per cent at December 2016.

The new management team expects the business to start to break even during the second half of this year and be profitable next year. Analysts at Shore Capital forecast pre-tax losses for the consumer credit division – which also includes online lender Satsuma – to narrow to £25.4m this year, from a hefty £119m in 2017, and turn to a pre-tax profit of £16.5m in 2019.

The sub-prime lender is now in a position to grow its loan book after it shored up the balance sheet by raising £300m in net proceeds from a rights issue in April. That capital was raised to cover costs associated with its ROP settlement with the FCA, which totalled £172m, including customer balance reductions and cash settlement. It also restored the group’s common equity tier one ratio to back above its regulatory minimum, after it was dented by the losses associated with the consumer credit division last year. At the end of March its CET1 ratio stood at 29.8 per cent, above a regulatory minimum of 25.5 per cent, equivalent to about £120m in surplus capital. That’s consistent with historic levels, management says.  

The outlook for Vanquis Bank also looks brighter this year. Not only has the group settled with the FCA over the sale of 'repayment option plans' (ROPs), removing a large amount of uncertainty over its prospects, but it has been making progress in growing customer numbers. They were up almost 8 per cent year on year to 1.72m during the first quarter. Meanwhile profits were a little ahead of management expectations with the annualised risk margin tracking ahead of full-year guidance. That built on an 11 per cent rise in customer numbers and 15 per cent growth in receivables last year.

However, analysts expect loan growth to be flat this year, partly due to tightening of underwriting standards and the impact of potential new FCA regulation on credit card customers in persistent debt, expected to be introduced this year. Management reckons this will affect future credit card application acceptance rates and its ability to offer credit-line increases. As a result, Shore Capital analysts expect Vanquis’s pre-tax profits to decline slightly this year, but to rise steadily during the following two years, reaching a record high of £210m by 2020.  

Admittedly, there is some regulatory uncertainty over Moneybarn, which is still under investigation by the FCA over the adequacy of creditworthiness assessments, as well as the treatment of customers in default or arrears with forbearance and due consideration, and the provision of information about termination processes. Management took a £20m provision against the expected cost of the investigation last year.