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Bond of the Week: 18 April 2013

New Issue: International Personal Finance (IPF) 6.125% 2020.

    

New Issue: International Personal Finance (IPF) 6.125% 2020.

All retail bonds issued onto the ORB now trade at a premium to par and many trade at a substantial premium. All yield below 5.5% at the offered side and most have now broken through the major “resistance” point of 5%. Into this market the offering of IPF, a newcomer to the retail bond market with a coupon just above 6%, should prove very popular. Here are the full terms:

Issuer:  International Personal Finance plc

Maturity: 8th May 2020 (7 years)

Coupon: 6.125% (semi-annual, May/November)

Rating*: BB+ (expected) from Fitch

Issue Price: 100

Denoms: £100

Min Subscription: £2,000

Books Close: 12 noon on 30 April 2013 (or sooner)

StatusSenior Unsecured Retail Bonds

Distribution: UK, CI & IOM only

Settlement: 8th May – Crest / Euroclear, TEFRA C

ISIN: XS0919406800

SEDOL: B9SL9X3

Listing London:  ORB

Sole Bookrunner: Canaccord Genuity Limited

 

IPF is “Son of Provident Financial”, Provident Financial being the most regular issuer on the ORB. Provident’s last offering was covered on Bond of the Week on15th March and may I refer you to it. You can then “compare and contrast” what was said then and what is said now. Both companies are FTSE 250 companies. The market cap of IPF is £1 billion versus £2billion for Provident.

International Personal Finance, like Provident Financial, is a supplier of what is politely known as home credit and impolitely known as door stop lending. Apart from being in the same business, the connection between the two ORB borrowers is closer still as IPF was spun off from Provident in 1997. IPF was the international arm of Provident and was demerged as a growth business from the mature business (Provident was founded at the tail end of the 19th century). The parent was deemed capable of supporting a higher dividend pay-out policy. IPF solely operates outside the UK but with a head office in Leeds (just down the road from Provident). Many of the personnel of IPF originally worked for the former parent before migrating over and the CFO explained he had been responsible for the very vigorous and prudent provisioning policy (95% after 3 months of arrears) that Provident uses.

IPF operates in Poland (40% of lending), Czech Republic/ Slovakia (20%), Hungary (10%), Romania (10%) and Mexico (20%). They have not opened in any new country since the onset of the financial crisis. They are, however, planning to open in Lithuania and Bulgaria in 2013. These have been chosen as they are in their area of expertise – Eastern Europe – and have relatively small populations (3.2 and 7.2 million respectively). Choosing smaller countries is deemed to be as a mark of caution.

Here are some numbers and a description of IPF’s business model. They have 28,500 agents who collect money weekly on a face to face basis in clients’ homes. Credit vetting is carried out by the agents and decisions to lend are made by the agents up to a limit set centrally by a process of behavioural scoring and analysing the application. Agents earn £10 per client brought in and 5% of money collected (minimising the incentive to approve uncreditworthy borrowers).  Sums lent are unsecured and for short periods (12-14 months) and for small sums (£50 to £1,000). Borrowers will be in employment (they do not accept those who are on benefits unlike Provident UK).

Debt recovery and a tight provisioning policy are of course key in the home credit business. Arrears are managed centrally and a policy of frequent contact (letter, telephone calls) is pursued rather than allowing the situation to fester. After 12 weeks of non-payment loans are written off but typically 10-20% of arrears are actually collected. If a single weekly payment is missed a provision is made even though in a 52 week repayment period it is the norm for there to be a missed payment or two.

The financial fundamentals are very strong (and better than Provident’s). For every £1 lent 58% comes from equity and 42% is borrowed (revolving bank facilities and bonds such as this one). To put it another way IPF has 58% Core Tier 1 capital – banks tend to have around 10% although calculating Tier 1 ratios for banks is considerably more complicated. And now to IPF’s profit margins. For every £100 of revenue 12% is paid in agent’s commission, 25-30% for impairment, 6% interest (e.g. bank facilities), 30-35% direct expenses (infrastructure network, admin centres etc.),  leaving a profit margin of 20-25%. IPF has been steadily profitable in recent years (£92million in 2010, £100 million in £2011 and £95 million in 2012).

This bond is rated BB+ versus BBB for Provident. The financial statistics of IPF are actually slightly better so what explains the worse rating? The management suggests (no-one can know for certain) that the reason is they gained their rating post the financial crisis when agencies were much more cautious whereas Provident had a rating well before 2008. An alternative reason might be IPF is a newer business and operates abroad in more than one country. Nevertheless it is arguable the credits should be of equal standing.

From a bond investor’s perspective what are the main risks? I surmise they are as follows:

A) Managing at a distance from the UK a hands-on business, like home credit, could in theory lead to a loss of control. However, having met the management they appear cautious, experienced and very keen on their prudential controls.

B) Shareholders may be keen on expansion and growth which could lead to unnecessary risk for bondholders. IPF was after all originally spun off as a growth business. Whereas Provident has the whole of the UK covered and nowhere to expand to, just about the whole of the developing world could beckon for IPF. This is a risk but in 2012 they set out a 5 year plan and while opening in new countries (Lithuania and Bulgaria) is planned, no intemperate rush for growth has been set out. Much of their plan is for qualative rather than quantative growth.

C) Regulatory risk. Steadily increasing regulation is a fact of life just about everywhere. However, despite sporadic bad publicity, whenever governments have looked at non-prime lending they have decided to leave it alone since they have quickly concluded that illegal lending would quickly fill the void. Interestingly many of the countries in which IPF operate (Poland, Slovakia and Hungary) already have usury laws (interest rate caps). This has been circumnavigated by offering direct centralised lending at the capped interest rate (20% in Poland for instance) and then charging an additional 50p in the pound when the client is signing up to home collections/ the agent service.  The extra 50p does not count as part of the APR as it is voluntary. Amazingly – and I checked this several times with the CEO and CFO  to make sure I had got it right– 95% of clients volunteer to pay the extra 50% for home collections. The rationale is that with home collections there is always some flexibility with late payment and there is no interest on interest for late payment. You can never owe more than you have contracted to pay at the outset. In short clients are willing to pay extra as a form of insurance or protection (but not that sort of protection) to avoid going down the Wonga or payday loan avenue. It might also surprise you to learn, and this is something the management is very proud of, that IPF has won many ethical awards. For example: Best Employer Hungary 2012, Non-banking lender with most ethical approach 2012 – Czech Republic and a Gender Equity/ equal opportunities award from Mexico.

D) Finally I have very few worries about potential liquidity problems or that IPF gets overwhelmed by bad debt. As mentioned they start providing almost immediately for bad debts and they have more equity than borrowings. They also borrow long and lend short. 96% of their receivables (what they lend) are sub one year and only 5% of company borrowings mature over the next year. To put it another way, IPF only has to freeze lending and within a year their entire book will have matured.

Conclusion. IPF is a conservatively run and profitable company. Their business model produces excellent cash flow and profit margins. They are issuing a bond at a level that is cheap (in absolute yield terms) to the entire market and that is cheap relative to the comparable Provident Financial, a company with the same modus operandi. The target issue size is not ambitious at £50-£75 million. Therefore it is difficult to arrive at any conclusion other than that this bond will quickly trade up to a premium and that the yield will contract down towards 5.5%. Given that the hunt for yield is ever with us, it might be foolish to look a gift horse in the mouth.

Oliver Butt 
Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income.

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