S&U — Ready to meet unlocked demand

S&U is an established specialist lender with businesses addressing the non-prime motor finance and the property bridging markets. Advantage motor finance has a record of strong, profitable growth. While it has been affected by the pandemic, Advantage is preparing for a strong bounce back in demand as lockdown restrictions are released. It has also continued to work on improvements to support longer-term growth. Aspen Bridging, a relatively new business, has gained experience and is scaling up to make a more significant contribution to the group while maintaining a conservative underwriting approach. The Coombs family own c 52% of the equity and management take a long-term, sustainable approach to the development of the group. The shares are valued at c 1.5x book, a level that would be consistent with an ROE of 14%; this is above the level we estimate for FY22/FY23 but below the pre-Covid-19 five-year historical average of over 16%.

S&U’s origins lie in a business founded by the chairman’s grandfather in 1938. That evolved into a home collected credit company and in 1999 a nonprime motor finance business was added with the foundation of Advantage Finance. The sale of the home collected credit business to Non Standard Finance in 2015 for £82.5m represented a significant change for the group and provided the means to finance a £15m special dividend and to invest in continued strong growth at Advantage and subsequently the formation of a new property bridging business (Aspen Bridging) in 2017.

Advantage Finance was formed in 1999 and is based in Grimsby with c 165 employees. Graham Wheeler took over as managing director in 2019, bringing extensive experience as a senior executive in the motor finance sector, while much of the management team has been with the company since launch. Advantage has a strong growth record and, at £247m, net customer receivables have grown at a 10-year compound growth rate of 20%, even after a contraction in FY21 as a result of the pandemic. The company has nearly 63,000 live customers and recorded 15,589 new transactions in FY21 (although pre-pandemic it had over 23,000 transactions in FY20). Advantage focuses on the non-prime area of the market, all loans are hire purchase loans and 90% of its lending is through over 40 brokers, with 5% each direct from dealerships and existing customers. The broker-sourced business is divided roughly 60/40 between internet and dealership brokers. S&U has relationships with the largest UK brokers including names such as Carfinance247, Zuto, Evolution Funding, Jigsaw and Midland Credit. This gives access to both large dealership networks and smaller local dealers.

Almost all the loan applications are submitted to the Advantage web-based system, which provides immediate in-principle lending decisions. The in-house IT capability at Advantage (about 10% of the staff) is an important enabler for the business as it helps maintain a high-speed response to loan applications (within 10 seconds for 95% of all applications) and rapid adjustments to systems to meet business requirements. An example of this is the introduction of a third credit rating agency (Equifax has been added to Experian and TransUnion) and the current project of merging of its data into the score card. The successful adjustment to working from home for most staff in FY21 validated the robustness of IT systems.

Most loans range from £5,000 to £8,000, with a maximum loan amount of £15,000; the average advance in FY21 was £6,581. The average original term was 52 months with a flat interest rate of 17.0% (c £11,700 repayable including interest and fees). The provisional approval rate for loan applications in the last financial year was approximately 25%, with c 0.38m out of c 1.5 million applications approved. The 15,589 that actually signed up in FY21 were therefore equivalent to about 4% of approvals or 1% of original applications. The small ratio of deals signed in part reflects buyers’ increased use of the internet to source finance before shopping for a car and is not onerous for Advantage given the automation of responses to applications. Advantage’s Dealflo esignature system helps to support the sign-up rate following approval, by guiding customers through terms and conditions and verifying their digital signatures.

Advantage had achieved 20 years of consecutive profit growth until FY21, reflecting growth in the loan book paired with successful credit control, underpinned by continuous refinement of a bespoke underwriting and scoring system, developed in conjunction with Experian and referencing a range of data sources. The pandemic affected FY21 results through substantial forward-looking impairment provisions. Exhibit 1 shows the development in receivables, revenue and profit margin at Advantage since 2011. Growth accelerated in the post financial crisis period (notably from 2013) when limited availability of credit created a particularly favourable environment with customers who might previously have been served by the incumbent banks migrating to specialist providers such as Advantage. Revenue and margin benefited subsequently with the latter rising to more than 40% for four years followed by a moderation as a result of rising broker commission and impairments, and, to a lesser extent, the withdrawal from the sale of gap insurance (2015). In FY21 the impact of the pandemic on margins was marked as increased provisioning almost halved the profit margin (see results analysis below for further detail).

Aspen Bridging launched as a pilot project in February 2017 to test the viability of developing property bridging finance as a diversifying activity and alternative source of growth for the group. In November 2018, S&U announced that it would move on from the pilot stage and invest further in the business.

Loans are made for refurbishment, light development or investment in the residential, houses of multiple occupation, prime semi-commercial and prime commercial market segments. The average original term is 11 months with an option for Aspen to extend the term by two months where appropriate; repayment is financed by sale or re-mortgaging. Loans are all unregulated (not owner-occupier) and are secured with a first charge. The maximum loan size was increased from £3m to £5m in January this year. S&U notes that it is addressing a market niche financing projects that larger institutions would find difficult to service with the speed and flexibility Aspen can offer.

Aspen follows a cautious underwriting approach with a process that includes third-party legal and valuation input, together with a site meeting with each customer by a member of the 15-strong Aspen team. Since launch 234 loans have been provided with an average gross value of c £500,000 and maximum loan to value of 71%. At end FY21 net receivables stood at £34.1m and during the year there were 80 transactions with a gross average loan size of £544,000.

S&U’s FY21 results were close to expectation and were strongly affected by the pandemic. Total year-end amounts receivable from customers of £280.9m were 7% lower, reflecting a combination of the impact of lockdowns and tighter credit criteria. Group revenue was also 7% lower. The most noticeable feature of the P&L was the more than doubled impairment charge of £36m for motor finance, reflecting forward-looking provisioning. Other cost of sales fell by 28% to £14m reflecting lower motor finance transactions. Administration costs were 15% lower reflecting a review of all costs at Advantage and a one-off overhead VAT reclaim of £0.7m. As a result, group pre-tax profit fell by 48% to £18.1m.

Further details are set out in Exhibit 2 including a half-year analysis. This shows that second half group revenue was only 4% below the first half, although within this property bridging activity bounced back resulting in a 57% sequential increase. This and the first-half weighting of motor finance impairments meant that second half pre-tax profit increased 87% sequentially giving a more moderate 34% y-o-y reduction for H221.

Looking more closely at Advantage Motor Finance results, there were 15,589 loan transactions, down 33% from FY20, reflecting caution on the part of customers and the limitations during lock-down periods on access to dealers and capacity constraints even for those customers who wished to use click and collect services. Transactions in the second half were slightly lower than the first half, but recovered to 80% of original budget by Q4 and were on track to reach 100% in March.

In managing the business Advantage focuses on cash collections and in FY21 the monthly collection rate against the contractual rate due was 84% compared with 94% in FY20. S&U notes that achieving this level of payment performance in the circumstances reflects the mitigating effect of its emphasis on customer relationships through clear communications, affordability analysis and forbearance. Exhibit 3 shows how the pandemic affected the payment profile in Advantage motor finance. Here S&U has included accounts on payment holiday as in arrears to illustrate the effect on cash payments (in the accounts, in line with Bank of England guidance, they are not counted as part of Stage 3 or credit impaired provisioning). In the analysis the proportion of net receivables where payments are up to date declined by 17 percentage points between FY20 and FY21. The over six months past-due category, at 10.1%, has seen the largest increase both over the year and compared with the half-year stage: a reflection of the impact of the pandemic on those customers already facing difficulties and the granting of extended payment holidays. Otherwise, the up-to-date percentage has nudged up since H121 and (not shown) the percentage of non-payment holiday accounts up to date was c 90%. At the year end 3,728 accounts were on payment holiday with the figure falling to below 3,000 at end March, and Advantage expects a reduction to below 2,000 during April.

As noted, the motor finance P&L impairment charge increased by more than 100% reflecting the forward-looking requirements of IFRS 9. While accounts where FCA-mandated payment holidays are in place are not treated as credit impaired, an economic overlay has been applied. A key assumption used in determining this is the level of UK unemployment.

Exhibit 4 sets out the analysis of balance-sheet loan-loss provisions for FY20 and FY21. This shows an overall increase in provisions from 18% to 25%1 of gross receivables with the increase arising in the stage 2 and stage 3 categories. Normally there are few stage 2 customers as all those one month or more in contractual arrears are counted as credit impaired and therefore in stage 3. Included within stage 2 for FY21 are customers who have requested a payment holiday and have had a previous delinquency or who have requested a second payment holiday, on the assumption that they have a significantly increased credit risk. The assumed loss rate on these customers is similar to those assigned to stage 3. The loss rate applied in stage 3 has been increased for those customers who have been granted a payment holiday; without this adjustment the level of impairment provision would have been £2.5m lower. While not expecting a write-back of provisions, S&U believes it has taken a prudent view in its provisioning assumptions, something that will only be demonstrated over the remaining life of the outstanding loans as collections are made.

Operationally, Advantage has been working to improve its sales offering, continuing to refine its business quality and underwriting, containing costs, maintaining regulatory standards, developing forbearance activities, enhancing digital marketing, developing new routes to market and carrying out a review of the electric vehicle market.

On the sales offering, a more aggressively priced product was introduced for lower-risk, near-prime customers (tier A+) and a selective return was made to lending to the higher-risk tier E. There was also a partial return to lending to the self-employed and a new rate structure has been adopted for this segment.

As noted earlier, a third credit rating agency has been introduced and work is under way to integrate its data into Advantage’s credit scoring system before carrying out a scorecard redesign.

Other IT work involves a redesign of the website portal, and search engine optimisation to target existing and previous customers.

Turning to Aspen Bridging, the business had a strong second half recovery with 55 transactions completed compared with 25 in H121, which was affected by a pandemic-related hiatus in activity. Full-year gross lending of £43.5m was at a record level and compared with £31.3m in FY20. Year-end net bridging receivables increased by 63% to £34.1m. While the average level of receivables increased by nearly 4%, interest/fee income was 6% lower giving a yield on average receivables of 18.3% versus 20.2% in FY20, reflecting changes in mix within a relatively small loan book. At the year-end only two loans were past due and since then no loans are past due or in agreed extension. The FY21 loan-loss provision was effectively unchanged at £0.7m and there were small increases in cost of sales and other costs leaving profit at £0.8m versus £1.2m.

Following the year end Aspen was approved as a Coronavirus Business Interruption Loan Scheme (CBILS) lender. These loans are backed by government guarantees, but normal Aspen underwriting criteria are applied. Applications had to be made by the end of March and need to be formalised by May. S&U indicated it could make loans of up to £40m under this scheme, although the net addition might well be lower given a potential reduction in normal business as the team processes CBILS loans. In addition to adding a significant tranche of debt to the book, the scheme lending will help establish relationships with new brokers and customers.

This section provides updates on some of the indicators we monitor when assessing trends in the markets for the Advantage and Aspen businesses and discusses the outlook for the two businesses.

Starting with Advantage, Exhibit 5 shows forecasts for UK GDP and unemployment as collected by the UK Treasury in March. Focusing on 2021, the average GDP forecast is above the figure included in the January compilation with the low estimate switching from a contraction to 2.1% growth and the average estimate marginally up from 4.5% to 4.7%. Unemployment forecasts are also more positive, with the average unemployment expectation slightly lower at 6.4% compared with 6.7% and new forecasts at 6.2%. Here the continued success of the vaccination programme improves hopes for more limited further restrictions towards the end of calendar 2021, bolstering business confidence and hence job retention. For Advantage, a key sensitivity is unemployment, so any potential softening in the peak level of unemployment against earlier expectations could be helpful (subject to the actual incidence of unemployment in the customer base).

Exhibit 6 shows clear signs of consumer confidence reviving as further easing of lockdown restrictions come into sight. Prospectively, if positive trends in infections and related data with the build-up of the vaccination programme are maintained then this should have a further positive effect on confidence. Conversely, developments such as the emergence of more challenging COVID-19 variants cannot be ruled out. Exhibit 7 shows that the unemployment rate has moved up although it is a lagging indicator and is still being cushioned by government job protection measures. Redundancies have shown a sharp increase, topping the level seen during the global financial crisis. However, the rate of redundancies may subside quite rapidly as economic recovery becomes established and has already shown a decline from its peak level in the latest reading for January. Unemployment may worsen before easing given the prospective ending of government support measures, which is likely to be reflected in the economic forecasts shown above.

Next are data on used car transactions and used car finance. Exhibit 8 shows the sharp drop in used car transactions in the first half of calendar 2020 when compared with the monthly figures for the prior two years. The striking point here is how well volume recovered following the initial lockdown, albeit with a dip in Q4 coinciding with the second lockdown. Exhibit 9 tells a similar story for used car finance with the additional point that the January reading was depressed with a 34% y-o-y reduction. The Finance & Leasing Association (FLA) looks for overall car finance new business to fall by 16% in calendar Q1 as a whole as the impact of the latest lockdown has been mitigated by the use of click and collect. Once showrooms reopen, the FLA expects a strong recovery in the market with the overall value of new car finance business for calendar 2021 growing by 17%, followed by 12% in 2022. Advantage is preparing for a bounce in demand as showrooms reopen on 12 April, mirroring the bounce in demand it saw following the initial lockdown in 2020.

As far as used car prices are concerned, these have been buoyant in 2020 and early 2021 with strong consumer demand and reduced supply pushing prices up; the Autotrader retail price index showed like-for-like increases of over 7% y-o-y in the five months to January. Auctioneer Aston Barclay has commented that there was some softening of prices in February but, looking ahead, it expects the release of pent-up demand in April to put upward pressure on prices with supply unlikely to catch up for a few months. A return to a more balanced market and lower prices in some segments could be hastened by increased repossessions in due course. For Advantage the exposure to lower auction prices on repossessions is limited by the relatively low value of the vehicles it finances.

Beyond the near-term bounce in demand, Advantage looks to achieve growth through gaining a greater share of the deals it approves, but where the loan offer is not taken up, by its work to address existing and previous customers through search engine optimisation, by widening the numbers of broker relationships, by winning more business through comparison websites and by developing affinity partnerships.

Looking at the background for Aspen Bridging, Exhibit 10 shows the number of UK non-residential and residential transactions with residential being most relevant for Aspen. Both have seen an extended post lockdown bounce with a stronger move evident for residential transactions. On a longer view, S&U sees an imbalance between supply and demand for good quality homes as a favourable backdrop for its customers who are refurbishing and developing properties. Additionally, as a small business, Aspen should have significant scope for expansion now that it is more established in the market and has gained experience having provided 234 loan facilities since it was founded. To this end the team has been expanded and the product offering amended with a longer original term (11 months versus nine) and larger maximum size (£5m versus £3m) than originally. The CBILS lending mentioned earlier could also give useful access to new customers and brokers as well as expanding the loan book in the short term.

As a balancing note to the broadly encouraging indicators set out above, it should be remembered that sensitivities remain for both businesses with maintenance of credit disciplines, regulatory developments, the nature of the macroeconomic background and funding costs and availability among the factors to consider. Also, both car finance and bridging markets are competitive and subject intermittently to increased pressure from new entrants or changes in competitor behaviour that could adversely affect results for a period.

In the next section we set out changes in our estimates and the group’s financial position.

Changes in the key numbers from our estimates following the FY21 results are shown in Exhibit 11. The figures for FY21 show our estimate (old) and actual outcome (new). As can be seen, the FY21 result was close to expectation and the changes to profit and EPS estimates for FY22 and FY23 are minor. Our new revenue estimate for FY22 is 8% higher, reflecting higher receivables and revenue growth at both Aspen and Advantage with a more cautious assumption on the impairment charge at Advantage largely offsetting this.

The next table gives details of our estimate assumptions. In the motor business we have allowed for receivables growth of 7% and 8% for FY22 and FY23, respectively (similar to our previous estimate), and look for a decline in the level of impairments in both years leaving FY23 impairments at 25% of revenue and the risk-adjusted yield (revenue less impairments as a % of average receivables) at 21.5% (FY18–20 average 25.4%). Bridging receivables are assumed to reach £84m in the current fiscal year followed by £105m as the business is expanded to a level where it makes a more significant contribution to the group.

The segmental cash flow analysis below highlights the major turnaround in cash flow at Advantage as growth was replaced by contraction during FY21. The pattern was as expected with the slowdown in advances outpacing the reduction in collections as payment holidays and forbearance took effect. As a result, the outflow of £6m in FY20 was replaced by an inflow of £32m. Aspen Bridging maintained good collections and debt recovery and with increased advances saw a greater outflow of £12.5m versus £1.8m. At the group level this left an inflow of £19m and net debt just below £100m and net debt/equity at 55%. Following the year end, committed funding facilities have been increased by £25m taking the total to £155m, providing headroom to meet the expected near-term bounce in demand for lending. On our estimates, net debt could rise to c £186m by end FY23 with net debt/equity at 92% (similar to our previous estimate and higher than historical levels – FY18–21 average 64%).

P/E comparisons with peers remain difficult to interpret given the impact of forward-looking provisions in the post-COVID-19 period so we continue to frame valuation using our ROE/COE calculations. If we assume a cost of equity (COE) of 10% and long-term growth of 2%, then the share price at the time of writing (2,250p) would be consistent with an ROE of 14%, which is modestly above the 13.2% we estimate for FY23. Arguably, even that year might not reflect a full recovery from the impact of COVID-19 with our assumed risk-adjusted yield still below prior levels and historically S&U has achieved higher returns on equity (the five-year average for the period FY16–20 is 16.3%).