Provident Financial, the most regular issuer in the retail bond market, has launched a new issue. First let me refer you to what was written in March 2012 by my excellent predecessor, Mark Glowrey, who previously covered new issue retail bonds. That way you can see what, if anything, has changed. To help, the Provident 7% of 2017 bond, then covered, is now trading at 105.35% but prior to rumours circling in the market about an impending new issue it was trading at 108%.
Incidentally while I am on the subject of Mr. Glowrey, he has just written a very good practical guide to investing in the Sterling bond market – The Sterling Bonds and Fixed Income Handbook. If you would like a scholarly read on the bond markets or a reference book you can lay your hands on next time you want to look something up, then this is one for the shelves.
Issuer: Provident Financial plc
Format: Senior Unsecured, Unsubordinated
Subscription Period 11 March 2013 to 22 March 2013 (may close early subject to RNS announcement)
Settlement 27 March 2013
Maturity 27 September 2021 (8.5 yrs)
Coupon 6% annually, payable semi-annually in arrears ACT/ACT ICMA
Listing London Regulated Market and the London Stock Exchange Order book for Retail Bonds
Sales Restrictions UK, Channel Islands and Isle of Man only
Denoms GBP 100 (minimum subscription GBP 2,000)
Joint Lead Managers Barclays / Lloyds Bank / RBS
Let us run through what Provident Financial does. They have two business lines: home credit and a credit card business.
Home credit, to put it bluntly, is the supply of credit to the poor but solvent. The business has been going since the 1880s and the management of Provident believe there has not been a single year since then that has not been profitable.
Loans supplied are typically around £500 and short term in nature (predominantly less than 1 year). These loans are underwritten face to face by 9,800 agents who see their customers once a week to collect the repayments. The borrowers are those who are unable to obtain credit elsewhere and will normally not be property owners or be in full time employment. However, they will have few if any debts outstanding elsewhere and are likely to have some form of casual work. Not surprisingly because of the credit risk involved and the administrative costs associated with doorstep lending, the rate of interest charged is high – around 90%.
Let us look at how Provident’s figures work for every £1 lent. They receive interest of +89p, suffer loan impairments of -33p and costs of -42p making a total return of 14p. Post gearing (the group as a whole has gearing of 3.2 times; it is not broken down by division) the return on equity (figure supplied thanks to Canaccord) for home credit is 38%. Provident has a market share of 60% and given this is an old fashioned mature business the barriers to entry are very large. What thrusting modern go-getting businessman is going to build up a network of nearly 10,000 agents?
The growth in Provident’s business is coming from the Vanquis credit card business (profits up from £44 million in 2011 to £77 million in 2012) with a return on equity of 37%. The target market is one step above the customers of the home credit division. The credit card is aimed at people who are in full time (low paid) employment but do not own their own home or have large debts. The management points out that credit standards are stringent and three out of four applicants are rejected. The initial credit extended is normally only £250 which can then be crept up if there is a sound payment history. According to the CEO owning a credit card is an understandable aspiration for these people and post the financial crisis there are not many card companies (Capital One is one exception) competing in this segment. Relative to other credit card businesses Vanquis is people intensive since there is a need to keep in contact with and on top of the card holders. “You have reached your credit limit”. “Don’t forget to pay a minimum of £5 this month”. “You have missed a payment, can I help?”Etc. etc.. The card comes with an appropriate interest rate of 40%.
With a share price up 235% since the end of 2010 the company is doing well but what are the specific risks to look at from a bond holders perspective? They are three-fold; liquidity, a substantial rise in impairments and reputational/ regulatory.
Liquidity is not a problem. Provident group is fully funded until 2015 via syndicated loans, private placements and bonds. They can therefore not suffer a “run on the bank”. Vanquis does actually have a bank – Vanquis Bank – which partly funds the credit card business. However, as the management pointed out at a previous presentation, given all bank deposits are guaranteed by the Financial Services Compensation Scheme (up to £85,000) if Vanquis needs a few more deposits they only have to tweak the interest rate and in the money flows and given the 40% interest rate charged on outstanding credit card balances, paying a bit extra on deposits is not a problem. Also the deposits are all for fixed periods so they cannot all be withdrawn at once. The important thing to take into account is that as with Paragon, the last issuer of a retail bond (now trading at 101 5/8%), the money financing the business cannot walk out of the door sinking the company.
Impairments are the crux of the issue non-prime lenders. The inflation level of utilities, food and fuel, which has not been matched by an increase in wages, has made the market backdrop for Provident’s core market difficult. Weekly contact from agents are crucial and the agents (who make the final decision of whether to lend or not) are paid on money collected not lent. Therefore Provident’s very necessary hand- on approach mitigates a lot of the risk. Impairments at 33% have been more or less constant since the start of the financial crisis. They also have a very strict approach to provisions. 95% of outstanding loans are provided against if no money is received for a 90 day period. Lending for too long a period along with too optimistic provisioning for impairments is what sunk Cattles, a major rival, some years ago. Provident are well aware of this and put credit management ahead of growing lending.
This brings us on to regulatory/reputational risk. There has been much comment in the press on the eye watering interest rates charged on pay day loans. Wonga, the best known name, charges over 4,000% on an APR basis. Provident points out that they do not offer pay day loans and you have to say the 90% they charge seems positively cheap in comparison. Most importantly Provident lends money out for a fixed repayment. No penalty interest is charged when a payment is missed. Debts unpaid do not roll over and do not continue to accrue interest. If a customer fails to pay £100, then a month later he continues to owe only £100. This is a huge difference compared to the interest on interest charged by those in the pay day loan business which can quickly bury the unwary under a debt burden from which there is no escape. Of course when you read that the CEO and CFO each have total emoluments of well over £1 million pounds (sums looked at in awe by the investment bankers bringing the deal) you have to ask about the justice of life. But then one should try to be rational rather than emotional when reaching financial decisions. Provident Financial has over 2 million customers and the company made a profit of £125 million so maybe the pay is fair. The recent report for the Office of Fair Trading opposes a cap on interest rates as they themselves conclude it would drive legitimate suppliers of credit away only for them to be replaced by criminals. As to any additional regulation threatened Provident says they would welcome it as they are better placed to comply than many of their competitors and at least they would know where they stood.
Conclusion: How will this issue go? This issuer is known in the market and is rated BBB (most retail bonds are not rated). The rating makes it attractive to small institutions and wealth managers who can be constrained in how many unrated bonds they buy. A coupon of 6% provides a good extra yield compared with where the existing bonds were trading a few weeks ago. Provident is also issuing in the ISA season when demand is high and so far they are the only issuer. I have to conclude, therefore, that the bonds will fly off the shelf. We ourselves have already seen good demand. I also think that the company is well and cautiously run so aside from any near term market performance, you are getting a good return for the risk and this bond can be bought to be kept.
Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income. The author and or the LLP may hold a position in or trade in any of the securities mentioned above.