Paul is a very knowledgeable and successful Investor and you can follow him on Twitter where he puts out a lot of useful stuff. His handle is @Hawkeye_74
Bought in on big fall as a result of announcement re. placing price of 30p which raised £10.75m. My view is this will soon be forgotten and the success of the company will rightly justify a rise back to previous levels.
P/BV at purchases was 1.718 (Ratio - Price divided by Book Value).
PCF held their AGM at 10:00am 8th March 2019 in a Serviced Office in The City. The meeting was well-attended.
The formalities were interspersed with questions from attendees at the invitation of the Chairman. An approximation of the question is in bold. The response in normal text and my thoughts in Italics:
The first question related to Directors' remuneration and how it is possible to justify a 45% increase for the Chairman, and similar amounts for other members of the board.
The Chairman handed over to the CEO to tackle it.
The main justification given was that being a board member of a bank involves increasing degrees of responsibility and the assumption of more onerous obligations; together with the possibility of recourse to individual members of the board in the event of any wrongdoing.
The CEO went on to explain that this was now an experienced board; implying that it was one which was at a level of experience and expertise commensurate with a bank as opposed to a finance company. He explained that the board now required regulatory experience which justified a higher level of remuneration. Furthermore, oversight from the PRA, who take an active view of governance, meant that the board had to be of a calibre consistent with that of a bank.
I view this 'increased' cost as one of purely being involved in this business area.
In response, the questioner noted that 15% of the increase in spend (I presume in the last FY) was on executive/Non-executive remuneration. How is this justifiable?
The CEO cited EPS growth. There was a swift retort that Total Shareholder return is a more appropriate measure.
A different questioner then seemed to go down a rabbit hole about why pay a bonus and why not just increase basic pay and how he felt the board weren't incentivised to outperform.
The head of the remuneration committee largely answered this. Pay had been looked at independently within the market place and been benchmarked vs similar organisations. They felt that as a result of the transition into a bank and along with the need to secure the executive team, the pay and structure of it was fair.
The questioner was hung up on salary vs bonus issues and wanting a greater salary component missed the whole point of variable pay. He didn't seem to realise that whilst the bonus was a high percentage vs the salary, it would not be paid in a bad year. Furthermore, paying all remuneration as a salary would actually lead to the CEO being less incentivised, as he wouldn't be working for his bonus. It did seem like the question was a banker bonus question, without realising that the bonus structure was in his interest as a shareholder.
The same guy then asked 'Can you explain to us how you are doing so well?'
Scott Maybury started by saying they are delighted with the first five months of this FY (upgraded forecasts to follow?). The numbers are impressive, but from such a small base perhaps it is easy to report big percentage gains. The key has been the use of cheaper funding, which allowed them to move into what they describe as a more prime area. 'Turning the taps on' in the prime area of the market has been a key development for the company.
They have a small market share which has gone from 1.75% to 3.5%. This has allowed them to operate largely out of sight of competitors. The increasing market share has resulted in a little more attention from competitors.
He then went on to talk about the importance of their broker relationships and how they are reliant on them for deal flow. Their modus operandi is to provide very good service and make it easy for the brokers to work with them by offering a rapid turnaround so that it becomes easy for brokers to put business their way.
Scott became animated when discussing this point and I did get the feeling he was energised by his business and must enjoy it to talk in such a way about it.
A follow up question asked for his definition of Prime.
Realistically and whether intentionally or not there wasn't a forthcoming definition. In essence, they are more prime than they were before.
I suspect that Scott didn't want to define their working definition of Prime for commercial reasons by the way he answered it. It probably makes sense to not give your competitors your client base parameters.
The elephant in the room was then tackled - the placing. Or rather the discount price of the placing. The questioner noted that he saw the discount of 17% vs the last placing being at a 5% discount.
The first point made was that this is a very different environment to that of the last placing. The brokers used undertook an exercise on recent discounts and that showed that they had occurred at similar discounts.
It's hard to argue with facts, but any self-interested broker could easily manipulate the figures just by adjusting the sample data.
Now the target is £750m, a fundraise became inevitable. They had been clear that the last fundraise in 2017 was to get to the previous target. As such, this should not be a surprise.
The clue here was that when the target next goes up that will be a cue for another fundraise.
It then became a judgement as to when. The board made the decision that they wanted to do it before 29th March 2019.
This is a prudent decision as trying to time the market given the potential macro-economic scenarios, is not a risk the business should be taking.
Whilst the decision had been made on timing, it was clear that there were a number of events which would work against a successful raise, namely:
- Financial Stocks are unloved - I don't buy this one as a good story is a good story regardless of the sector.
- Unhelpful headlines about banking participants - Again, not relevant to this story.
- Size of Company - The only pertinent point, possibly along with the timing being in investees favour.
They would have preferred a much tighter price, but took the view that they wanted the money at the price available. He did believe that the uncertainty now was greater, so it could have been even more difficult to raise funds now.
Debatable, but it is fair to say they made a judgement call on timing based on all the facts at the time and that cannot be criticised.
Finally, it was acknowledged there was a greater dilution and lower price than they would have liked.
Seventeen institutional investors were on the (Fundraising) roadshow. Of which 50% had been seen before. They did bring in some new names, but many chose not to invest.
Question about cost of raise being £500k and whether any success fees had been included in the fee structure.
It wasn't structured that way and they have never done in that way before.
Fundamentally, this demonstrated a naivety towards the operation of financial markets and the negotiability of pricing. It also undermines a previous point made about extensive experience of the board in financial markets. Being balanced though, it is easy to be dazzled by a City guy promising large amounts of cash. However, as a shareholder I don't want this to be a recurrence and it prompted two questions from me.
Have you considered a review of your brokers?
Pragmatic answer that will take that suggestion on board.
Did you seek any independent advice on the process of the fundraise to potentially save costs and increase possible success?
Not thought about that before but again will take the suggestion on board and consider it for the future.
Question on the £750m target and has the target slipped by a year?
Got to £350m target early, but not going to bring £750m target forward by a year as a result. They will not change the approach but they will bring in greater diversification as a part of growth.
Question about quality of communications in a sector where proven difficult to add shareholder value historically. In short the questioner wanted the company to give more specific guidance for numbers i.e. he thought FY 22 net income of £18m was achievable.
The Bloomberg consensus f/c net income for FY 22 is £16.9m.
Polite response that they are careful about the message they put across. Subtext, we're not going to put numbers out to get hung out to dry on at a later date.
Question about 3 year target (£750m) and biggest challenges to the business now.
Credit risk - Economic conditions and collection of the book are their key risks.
He went on to talk about the different stresses that appear from different recessions, I.e. 1990s unemployment & high interest rates, whereas 2008/9 was about credit withdrawal for business. The key take away here being that he noted that in 2008 if an individual kept their job they may well have found themselves better off if they had had a variable mortgage. 2009-11 SME defaults were the issue but the consumer was in many ways unaffected.
Therefore, the issue for PCF is what sort of recession is likely. His main pre-occupation was whether it would be a consumer or business led recession.
Follow up Discussion with Scott Maybury
On the challenges of the fundraise
Whilst he didn't specifically cite it in such a way, it was clear from my conversation with him that the sub £100m market cap was the primary issue they faced. In good markets a lot of the institutional investors will be flexible on this if it is a good story, but at the time they were doing the raise it was a rigid number for them. I mentioned a couple of major institutions e.g. Blackrock, M&G, and it was clear that a few of them refused a meeting. He was candid enough to say when they saw the roadshow list and those not on it, it was clear that it was going to be tough to get the placing done successfully.
This is factually correct. £100m is often an arbitrary number below which institutional investors won't take a meeting. However, it does prompt further questions about the story. If the story was compelling on first glance then a meeting would result even if no investment followed. The fact that no meetings were convened suggests either the broker did a poor job or that the story was not felt to be compelling by the individuals approached. This can only ever be speculated upon.
It's now clear that once £100m market cap is reached that will be a very positive development and could be the catalyst for a further re-rating or a signal that a fundraise will become imminent.
I asked about target CET ratio and how it compared to others, suggesting that it may well be too high.
They are in the 14-18% range. The PRA (Prudential Regulation Authority) come in frequently to assess their model and give them the CET ratio to solve for (i.e. PCT operate their Business in a way that their Capital Ratio meets the PRA requirement). He said it will never be publicly stated what that is.
Think it’s a fair assumption, that it will be closer to 18 than 14.
I wanted to ask a follow-up about the learning points, if any had been thought about, in the wake of the Metro Bank failings with regard to their model but didn't get the chance.
Along with another investor we discussed their broker choice and whether they were appropriate going forwards.
Scott had a pragmatic response that perhaps they weren't the best broker.
Again I felt a naivety about how they interacted with the City.
When I talked about a bigger bank/broker potentially having a better global reach for potential investors, he was keen to learn of any introductions that might help.
I asked if they had thought about raising bond finance, specifically a Coco.
It is possible, but the PRA do set limits on that and he mentioned Upper Tier two as a potential source of funds.
I got a good sense from Scott Maybury, that he was a considered Chief Executive and was on top of most of the issues within his business. He was humble about the size of the business and careful not to make any grandiose statements about its potential, yet clearly driven. His longevity in the role is a significant positive. With the benefit of a City background, I can see how he can improve his interaction with The City to protect shareholder value going forwards. However, he seemed willing to take advice from a random shareholder, which made me walk away with a favourable impression of him and the business. I suspect that the placing discount will soon be forgotten and with operational success I will continue to champion this business as a shareholder.
Interim Results 5th June 2019
If a conference call is not done well it can reflect badly on the company. They take pride in being the only listed bank on AIM, they should present with the professionalism of a bank! Parts of the presentation were not tackled clearly, particularly on the part about impairment. Responses to questions were often poor and in some cases Michael Howard'esque in efforts to avoid answering. When obfuscation occurs the risk is it leads the investor to think the worst!
The call referred to the presentation:
- 4 business lines vs 2 historically. All business areas moving into the prime segment.
- Issuance of tier 2 facility - which seems to be being structured like a revolver type facility, though not clear - will give them a 2/3 year grace from the need for equity raises. Noted the prescriptive nature of how much can fall in this bucket. I took this to be £15m and will be issued with an 8% coupon. I presume given size and coupon it will be a bilateral issue direct with a lender.
- Somers remains the majority shareholder and PCF remains consistent with their strategy. Should have asked why didn't take up the offer despite having this question answered before.
- £350m loan book by FY20 will likely be reached this year.
- Azule purchase resulted in £4.6m of capital being used.
- Bridging market being entered, much of the work initially was on systems, PRA approval etc. Made first loan in the reporting period.
- Impairment charge 0.9%; underlying is 0.7% but IFRS 9 which works on 'expected business' results in an increase of 0.1%. There was no explanation that I heard as to what the other 0.1% was. I'm led to believe on very good authority (thanks to another investor) that the other 0.1% was due to credit cycle tightening and provisioning at higher levels. Incidentally, that is what led to an investment in the collections process.
- There was then an explanation where the £500k went but I didn't really follow what was being said about it being put in B/Fwd earnings and there being a £100k impact this FY and £200k next year.
- This part of the presentation was handled badly.
- Restatement of the aim to maintaining ROA (Return on Assets) - operating efficiencies will start to impact as they grow.
- Available for sale assets are gilts & TFS funding (Term Funding Scheme from the Bank of England). Gilts repo'd out. I bet they are getting ripped off on repo rates. Bank repo desks are historically big profit generators.
- Due to banks has the £11m of repos.
Consumer Finance Division
- Modest growth seen. Acknowledged they need the right product which is not just about the rate, but rather about speed of decision. Implies they had been missing out on business due to turnaround time. Historically quite a manual process. Have engaged with Experian to come up with a credit scorecard system. No mention of cost of system.
- Success has come from the fact that they focus on niche areas e.g. classic cars, horse boxes etc.
Azule purchase provides a direct route to market. Has been a successful first 5 months of ownership.
- B/S increased to £19.75m
- Aim now is to fully integrate middle & back office.
- Bridging - been building systems etc. Wrote £2.6m to pro property investors who generally buy at auction and exit will be sell or refinance. No questions on aspirations for the business or competitive nature of market. Ask about S&U and entering market at the same time.
- Portfolio is improving 75% remains old PCF type business.
Impairment - 0.5% with old portfolio was not sustainable so expected it to increase. Never heard chat about this before so the way it was presented was not helpful. 3 drivers:
- Old portfolio was not sustainable at 0.5% so expected this number to increase.
- IFRS adjustment would add.
- Economic conditions - personal insolvencies at high levels and modelling for these variables in terms of where we are in the credit cycle and forecasting for it will impact on expected impairments.
- Has been an increase in accounts in arrears - so increased resource into collections dept.
- The way impairments was tackled was weak in my view; there was not enough explanation and poorly messaged.
- Duration of some loans is now increasing which means due over 1 year category increasing proportionally.
- Looking for £250m of origination this FY across 4 business lines rather than the historic 2.
- £350m portfolio target will be reached this year. New target is £750m as previously stated.
- Impairment should be below 1% this year. Which should be expected for Prime/near Prime.
- Focused on top line growth and investment in infrastructure.
- ROA target is 3% (2.7% annualised for 1st 6 months). £750m loan book = £20m PBT (This implies £2.5m costs given 3% is £22.5m)
- Dividend policy. Business is capital intensive but appreciate the need for a dividend even if a small one. Will be progressive.
- Targeting ROE 15% in FY 22.
- Believes there is good execution of the strategy.
- Only AIM listed bank.
2 new business lines with low impairments:
- Azule had very minor impairments of just £15k in year purchased.
- Bridging has low impairments but not sure if that was expected or at industry level.
- With regards to impairments relying on the forecasting of economic conditions - so being cautious. As a result believes it is sensible to set a charge which they can live within.
Question (generally difficult to hear questioners)
- Business - increased rates in May.
- Consumer - improved rates in Feb - not sure what this meant so ignore.
- Finance guy totally avoided the question and was painful to listen to. Whether he didn't want to give it away or not it lead to a rambling answer that avoided the question. This kind of answer only leads to more questions. He did say they were now in the top 2 credit grades that they weren't in before they were a bank. I think Scott Maybury stepped in as it was seeming a bit like Michael Howard being interviewed. Stated they're not in the most prime but in the top half of the Prime band. Clear as mud. If they don't want to answer the question just say so. We all appreciate business discretion. The questioner even retorted something like “so you're not going to define it then”. Ended with them stating they're not turning away near-prime lending either.
Question on used car rates
- 5.9% on AAA rated credits to 20-25% on C rated credits. See, that wasn't so hard was it! Prompted a follow up about risk based pricing. Scorecard system not yet live but it should improve the speed and quality of decision making. My notes at this point said he doesn't present well this chap (finance guy).
Question about Azule and scale of opportunity
- Was about quality of the business and people. Would look at similar businesses but plenty to work on here.
- Is a small market and Azule have 60% of the market and they have increased volumes since purchase.
- Stated not much growth in the market. But there is potential to move into other areas e.g. screens at live events.
- Building relationships with manufacturers will also help.
Was then asked about depreciation of underlying tech if a default:
- Was clear he didn't know but fair enough as a new business and managed to steer his points to what he did know, i.e. cost of a lens £80/90k and precision manufacturers have order books generally well in advance. So in short, will be resale value.
- Broking on. Majority of it is Prime (no definition though) but were not happy either through not liking credit risk etc., will broke it on.
- First aim with purchase was to support not disrupt. But at same time implement behind the scenes integration.
Cost of funds 2.5% but couldn’t hear the question
- TFS funding of £25m was benefit in Sep/Oct as previously held gilts, but now hold own loans therefore can release cash.
- Block funding historically at 5%.
- Retail market competitive on savings side. New entrants weekly, but once strip out this effect levels generally stable.
- TFS will have to be repaid in due course. Not sure when.
My general feeling is that nothing much is changed to the investment thesis by these results/conference calls; namely the potential for growth in a fragmented market place. The conference call did more harm than good in making the company seem amateur. Scott Maybury comes across as well considered and good on detail but David Bull (Finance Director) prompted more questions than answers. For now, I have to give him the benefit of the doubt and hope to get another opportunity to garner a better impression of him. I have questions about the move into bridging as this is already a competitive market in which other new entrants are also looking to build a loan book. Share price reaction very muted implying the marginal new buyer is not getting interested. This is hopefully to my advantage in the long run as a Shareholder. In summary, my reasons to hold continue.
Investor Presentation June 2019
- £15m Tier 2 only drawn when needed. Not needed for some time yet, so a cost-efficient approach.
- Somers (majority shareholder) also own stakes in Waverton & Utilico.
- Scott Maybury thinks we are near the top of the credit cycle. Perhaps 18 months away.
- Was clear that the impairment charge will increase if macroeconomic environment worsens.
- Return on Assets target remains 3%. Currently 2.7%.
- Average after tax return on Equity target is 12%. Currently 11.4%.
- CET1 ratio 19.7% - I never understand why it is stated this way but Scott Maybury states they can't say what it is?
- Business Finance - Generally a 3-5 year loan, for which it becomes more secure over time as amortisation of loan becomes greater than depreciation. So generally good resale potential of the collateral.
- Consumer Finance - This is the division for which I do have some concerns. Average deal size £15.5k. Interesting to know that Santander will take out super prime lending and then PCF on a panel to take next tranche of loans as they originate.
- Azule - Generally 3 year loans and assets e.g. lenses hold resale values. Has a 60% mkt share. Originates £60m business pa. Reasons for purchase: like the underlying assets of loans, high quality people who are tied in, offers a diversification of income streams. Also a direct route to market i.e. have relationships with OEM (Original Equipment Manufacturers) e.g. Sony. So no brokers involved as far as I can tell.
- Bridging finance - All is first charge lending. I have doubts about this endeavour as whilst they state it is capital efficient, I understand it is very competitive and new entrants are also becoming increasingly involved. To their credit, it seems a slow roll out, which could allow initial mistakes to be avoided and not engaged in buying a specific Bridge finance co.
Outlook - I really like that they know that £53m of future operating income is identified. The existing loan book (of course subject to impairments), gives a certainty:
- Scott Maybury requires credit for longevity in the business and understanding of the credit cycles. He demonstrated an understanding of how bad it can get by citing the impairment rate in the GFC (Global Financial Crisis – 2008) of 5%. Therefore, this is a qualitative measure of him alone that has to score highly. He holds 0.69% of the mkt cap, which may or may not be significant to his personal wealth. Should represent enough for him to avoid doing anything really stupid.
- Portfolio target of £750m & RoE of 15% by 2022, gives a clear sight of the potential.
- Portfolio of prime credit quality delivering <1% impairment charge - I would take issue with this as their definition of prime is at best opaque. Nevertheless, managing the impairment charge is a clear priority as is collections.
- Progressive Dividend - this is not an income play as capital hungry.
Other thoughts / follow-on discussion
- Current financing won't take totally up to £750m. More likely £680-700m. So another equity raise is not an unexpected event before 2022.
- M&A (Mergers & Acquisitions) - Not in residential mortgages and not actively pursuing M&A as got plenty to work on, but gave the get out that opportunities will come up.
- By 2022 will be mature business in both Business Finance & Consumer Finance.
- Today loan book at c£290m.
- In response to a question about capital raise expectations holding back Share Price, Scott Maybury gave an eloquent answer and his reasoning on timing makes total sense. He also pointed to a general dislike of banking stocks. I'm not sure this applies here as the comparison isn't really valid. What is valid is that the Mkt Cap needs to increase to attract new institutional holders.
- NIM (Net Interest Margin) - Medium term target is 7%, which is below current level. Believes this is achievable based on niche product areas, but flagging it will fall gradually.
- Make up of loan types: Bridging - 6-8mths, Azule - 3 yrs, SME 5yrs, Specialist (e.g. coaches) up to 7 yrs.
- Credit control - 14/15 people. Don't sell debts on as can achieve 75% recovery. Front line is 11 people chasing debts (was up to 17 people in 2011).
- Prime credit customers can borrow at 5%. Non-prime 18%. I do suspect a High Street bank definition of prime might equate to PCF's super prime. Nevertheless, still offers insight into how to get to NIM.
- A long way from the cheapest in the market - get custom as easy to deal with for brokers, because for them losing the deal is a primary concern so will not deal with the lender who can't complete easily. Clearly a major selling point.
- A credit downturn? Arrears and impairment will increase. 2009 had a 5% impairment charge but was still profitable today is 0.9%. I do like the historical context as I don't think we have a 2009 event, but rather a 2011 type scenario is more likely.
- Tier two facility - 20bp (Basis Points) non utilisation fee. Whilst it is an expensive coupon it is a rational way to access capital. Scott Maybury demonstrated that he had investigated tier 1. A Swedish fund had offered 7.75% + libor. As he doesn't need the money until next year, the tier 2 approach seemed most sensible. I agree as taking tier 1 would have been a bullet and dragged down performance and might have prompted a relaxation of lending criteria to deploy the cash.
- Impairments - 95% of the impairment charge is the reality. 5% is the modelled amount. Steps in impairment:
- 1, Take asset and sell to recover - average 75% as don't sell the debt.
- 2, Court judgement on loss results in the £100 per month kind of repayment so takes a long time to work out remainder.
- 3, Most assets come back ok and can be re-sold. Always some which they find on bricks when they recover. 0.9% is current reality.
I buy into Scott Maybury and his approach to marshalling this business. He has clear plan for loan growth, has an appreciation of the risks inherent in the business through his longevity and makes himself available to his investor base. There will be another capital raise to get to the loan book target of £750m, but this could be over 2 years away. It remains a growth story and the risk to it is an understandable one. If they have got it right the impairments will be manageable and not overwhelming in a credit downturn. The niche areas in which it is increasingly positioned provide defensive characteristics too. It is not an income play but rather capital appreciation as operational performance is increasingly valued as well as the potential for operating leverage to work its magic with growth. There is the potential also, that a bigger operator could buy it purely for the banking licence. Finally, with a current P/BV of 1.44x, the potential to re-rate to its 10 year average to 1.92x suggests a price in excess of 40p should be achievable as prudent growth is demonstrated.
Questions I have
- What is the industry standard default rate for a portfolio with the make-up of PCF?
- Clarify nature of tier 2.
- Somers no take up of Offer?
- Azule purchase - if not about growth as stated on the call, what was the primary driver of the acquisition?
- When comparing to S&U who detail impairments according to date i.e. past due 3-6 months, past due over 6 months or default. S& U detail impaired as anything past due up to 3 months. This means S&U Impairment is 16.1% whereas PCF on seemingly same measure 1.62%.
To watch out for next time
- Growth in Consumer Finance originations very slow as at 31/3/19 - £28m previously £29m in this period. Stated expected growth in this area later in the year as a result of automated decision making and superior customer support.
- Potential deterioration in ‘past due’ part of portfolio to decrease further. At 95% not sure what it’s 95% of.
- Loan loss provisioning seems very formulaic. What is actual nature of default rates?
Just got sent a bond offer at 7.48% for International Personal Finance (IPF). Impairments there running at 26% and massively geographically diverse operating all over the place including Mexico. Makes PCF seem a much better risk. Operating margin far worse though ROE superior. Interesting to compare the two,
S&U (TIDM Code: SUS) is largely a motor finance business but with a recently formed Bridging business. So is less diversified, but is bigger. Mintel thinks bridging finance grows from £7.5bn to £10bn per annum by 2021. They expect revenue growth of at least 50% per annum over next 2 years. The bridging proposition is based on the fact that the mainstream banks are not adept at providing bespoke finance which is fast and flexible. Motor finance is in the non-prime part of the market.
Net receivables FY18 in motor finance £259m based on 59,000 customers. Total loans amounted to £277m at FY. Not impaired was £231m 83%. Of impairments past due up to 3 mths £32.201m 11.6%; Past due 3-6mths £4.256m 1.53%; Past due over 6mths or default £8.213m 2.96%. Runs at a higher notional interest rate but PCF impairments stack up well by comparison. PCF FY18 Total loans 270,185. Total impairment amounts to 4,369 = 1.62%. Impairment charge for year FY18 £915k. PCF doesn't break down impairments but by comparison this suggests a well-run loan book, where impairments look far lower than a comparator.
After 1PM’s (TIDM Code: OPM) last results the fall off in its share price seems overdone and makes it look cheap, but having not looked at it closely and accepting that it operates in a more risky part of the lending market along with broking on a lot of business makes me think that there is something that the market has a fundamental issue with, given its P/E Ratio(Forecast) is c4x along with a P/BV of 0.49x. If 1PM proves to recover well then this looks by far the cheapest way to play this part of the market.
Simplistic comparison of Operating margin presents PCF as one of the best in the sector & on a P/BV it is not the most expensive in the sector but nor is it the cheapest. The forecast P/E demonstrates that this isn't the cheapest way to play this sector. However, each player looked at operates in a slightly different area and has slightly different issues, so I remain comfortable that in its arena it is a good company to buy into based on its fundamentals.