Non-Standard Finance plc (LON:NSF) is the topic of conversation when Hardman and Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: Non-Standard Finance has had a pretty tumultuous year or so, what did we learn from the recent results?
A1: NSF’s interim 2020 results reflected the pain of COVID-19, with i) lower volumes, ii) changes to business models, and iii) higher impairment, including an increased weighting of a severe macro downside, raising IFRS9 cyclical impairment charges.
Despite these pressures, both the branch (ELD) and home collect (HCC) businesses were profitable. A young customer demographic meant the guarantor loan division (GLD) was most affected, with COVID-19 effects, which will be compounded by the recent FCA review in 2H’20. It took a large charge in the first half for guarantor loan redress and, given the fall in peer share prices, NSF wrote off all the goodwill on historical acquisitions.
Consequently, it reported a large statutory loss and much reduced equity base, but NSF is still a going concern (end-September cash £70m), and the largest shareholder appears supportive of an equity raise post the FCA review.
Q2:What do you think investors will focus on the most?
A2: As noted, we believe there will be attention on the going-concern comments. As a result of the expected cost of customer redress, under the base case, NSF expects to breach covenants in the next 12 months, and solvency will be dependent upon i) the ultimate cost of the proposed redress programme being equal to or less than the provision being made, ii) the cost of any waivers granted from lenders, and iii) any mitigating actions that could be implemented to offset any adverse movement from the base case, as the group may have to further restrict lending activities and/or exercise further financial levers around costs in order to maintain solvency.
Therefore, in arriving at the conclusion that NSF is a going concern, the directors judge that, if required, the group would receive the requisite support from lenders and/or shareholders in the form of covenant waivers and/or further equity capital. As noted, Alchemy has confirmed that it remains supportive of a substantial equity issue and is actively engaged with the group.
Q3: And what is happening on the guarantor loan issue?
A3: With these results, NSF advised that, in conjunction with its advisers, it had developed a proposed guarantor loan redress programme, based on the general guidelines the FCA had previously sent to them. NSF now needs to await the outcome of the FCA’s review of its proposals, and the company was not permitted to discuss with third parties the remedies or its proposals.
We believe the company will have been rigorous in coming to the £15.8m provision taken in these results, but external parties are not in a position to assess whether this may prove too low or too high. NSF also confirmed that, once the proposed programme had been agreed with the FCA, it would then re-engage with shareholders about an equity raise and that, based on current information, Alchemy was supportive.
In addition to the remedies and costs, the division’s performance is affected by minimal new lending and increased arrears. This is not expected to reverse until 2021. Additionally, as noted in Amigo’s 3 November announcement, there is a risk of increased activity by claims that management companies could see higher numbers of complaints and associated costs.
We also note a much more detailed exploration of wider regulatory developments in this release, and, given the developments in GLD, some caution on regulatory risk is only to be expected.
Q4: What about the upside?
A4: Non-Standard Finance was already in advanced discussions with major shareholders about an equity raise before the guarantor loan review was announced. We understand that commentators had quite a range of outcomes (£15m to £40m), and we would expect this to increase by at least the amount of redress provisions (i.e. to £30m to £55m). The largest shareholder appears supportive and knows the business well having been a previous owner of Everyday Loans. Given Alchemy’s current near-30% holding and the current market capitalisation (£10m), it is quite possible that Alchemy will become the majority shareholder.
We provide a scenario analysis in our note, which highlights the opportunities from an equity raise as being: i) Loan book growth can be massively accelerated, and with faster revenue growth as wider-margin new business becomes a greater proportion of the book. ii) Impairments will rise, given the IFRS9 new business charge but better-quality business can be written, meaning the rise in impairments should be slower than revenue. When macro conditions improve, there will be a reversal of the IFRS9 cyclical charges, with an increased weighting to upside scenarios, which will reduce impairments. iii) Costs rise significantly more slowly than revenue, with the usual economies of scale and capacity currently available in the branch network. iv) Funding costs increase but, again, this will be at a slower rate than revenue, as equity will be a higher proportion of the funding mix.
Overall profits and profitability both increase sharply. The EPS effect will clearly vary by the amount of equity raised.
