Non-Standard Finance (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 had a severe share price reaction to its recent trading statement. What can you say about it?
A1: NSF’s trading update had three elements.
First, there was a 4-5% reduction in current year consensus estimates due to softer trading in Q3 (primarily lower loan volumes in guarantor loans, a market which has been affected by adverse press coverage and company specific operational issues).
Second, there was a 6-8% reduction associated with a step change in provisioning policy assumptions. There is a known cyclicality inherent in IFRS9 as its calculation of credit impairments requires companies to give a weighting to a range of possible economic outturns. As you go into a recession, the weighting for the downside scenario increases so provisions will increase even if customers continue pay exactly as they were before. IFRS9 anticipates future losses and what NSF did was increase the weight to the downside.
Finally, NSF is indicating tighter lending criteria and so slower lending growth. Even after all these we are still forecasting 2021 adjusted profits to be double the 2018 level.
Q2: So, tell us more about the softer trading?
A2: The key driver to the 4-5% trading downgrade is thus lower volumes in the guarantor loan business, especially in September and the expectation that with the move to Trowbridge there will be a period of disruption that will take a few months to get back to previous run-rates. Management noted a number of company specific issues including a change in management and keeping two separate sales functions.
We note there were record volumes in July, near record in August and the fall off was primarily in September. This timing may also suggest that adverse market publicity has had an effect (although the company said there was no evidence to confirm this).
To address the slower than expected loan book growth, NSF is accelerating the consolidation of all functions into one site by nine months, which should see cost savings ahead of expectations and also realise a number of operational efficiencies.
Q3: And the assumption change?
A3: It has always been known that IFRS9 has cyclicality. The methodology includes a weighted probability assigned to different economic outturns and as a recession approaches a greater weighting is likely to be assigned to downside scenarios than when the outlook is more positive. NSF moved from 85% base case, 10% downside 5% upside weighting to 50% base and 50% downside, which we believe is in line / above where peers have got to.
The change in weighting applies to the existing loan books for both branch-based lending and guarantor loans and so in 2019 there is a step change effect. In future years the effect is less as the higher weighting will only apply to new business. It is also worth noting that the change in assumptions has had a material impact on provisioning in branch-based lending and guarantor loans but is not visible in home collect. This reflects the historical relative stability of credit in the business in a downturn and so there is less sensitivity to downside scenarios.
Q4: Finally, you said Non-Standard Finance had slowed growth assumptions. what can you say about that?
A4: Management has revised some of its medium-term targets (i.e. over the next three years or so) to reflect the current uncertain outlook as management tightens scorecards. The biggest volume reduction is in guarantor loans where having enjoyed a period of significant loan book growth (H1 2019 saw growth of 53% versus the prior year) growth is now expected to moderate to between 15-20% per annum. Branch lending growth has reduced from 20% to 10-15%. As we move into a downturn and the 3-year outlook is for recovery, the old target may get re-instated.
