S&U — Maintaining cautious approach

S&U continues to experience good volume in both Advantage and Aspen. In Advantage, we have increased our net receivables estimates for FY24 to £330m (previously £325m) and £337m in FY25 (previously £334m). In Aspen, we have increased our net receivables assumption to £131m and £160m in FY24 and FY25 respectively, compared to our old estimates of £105m and £115m. As a result, our revenue assumption for FY24 and FY25 has risen by 1% and 7% to £114m and £133m, respectively.

In Advantage Finance, live collections dropped to 91% in the period, compared to 94% in H123. With used car prices falling and unemployment on the rise, we have increased our impairment assumption to £17.8m and £22.8m in FY24 and FY25, respectively, from £15.2m and £18.6m. However, we do highlight that Advantage Finance has an aggressive provision policy – ‘all loans 1 month or more in contractual arrears are deemed credit impaired and therefore included in IFRS9 stage 3.’ In Aspen, our impairment assumption has also increased in line with net receivables growth. Our impairment forecast has risen to £1.1m and £1.9m from £1m and £1.5m in FY24 and FY25, respectively.

Management stated that its relationship with the FCA has become more ‘formal’ following an examination of S&U’s ‘collecting processes, procedures and policies’. As appropriate, and alongside other lenders in its industry, S&U has appointed a Skilled Person who will communicate with the FCA and work to implement the FCA’s standards into the business. There has been no indication of a timeline on how long the process will endure but we draw confidence from Advantage’s strong record with the Financial Ombudsman Service, which S&U will operate swiftly to align its processes with the requirements of the FCA. S&U has an uphold rate of 15%, the best in the motor finance industry. The uphold rate refers to the percentage of complaints that were found to be in favour of the customer. Accounting for this process, we have marginally lifted our administrative cost assumption for both FY24 and FY25.

We have increased our finance cost assumption by 5% and 26% in FY24 and FY25 respectively as we anticipate that S&U will continue to fund growth with borrowing. In the trading statement, the group highlighted that its borrowing increased from £183m in H124 to £209m as of 11 December. It has total committed facilities of £280m. Hence, combined with the increase in impairments and administrative cost assumptions, our PBT forecasts for FY24 and FY25 have fallen by 8% and 11% to £37.5m and £39.4m, respectively. Consequently, our EPS figure has fallen by the same proportions for FY24 and FY25. Our dividend per share estimates are unchanged.

In this section we update our compilation of UK economic indicators relevant to consumer credit markets.

To summarise, GDP growth and inflation expectations for 2023 have edged upwards to 0.5% and 4.6%, while unemployment assumptions remain at 4.4%. Consumer confidence improved from October’s data as headline inflation continues to fall and the British public’s assumptions on inflation in the next 12 months has improved from previous estimates. UK used car transactions remain robust and while prices are beginning to falter, they remain at elevated levels. UK non-residential transactions remain strong whereas UK residential transactions continue to decline. Meanwhile, UK mortgage approvals continue to hover at subdued levels not seen since 2010.

Management acknowledges the unfavourable macroeconomic environment but remains confident in the group’s historical performance and experience to emerge from this economic trough stronger than before.

Headline inflation for October 2023 was 4.6%, down from 6.3% in September. Lower inflation was driven by cooling prices in housing and household services alongside food and non-alcoholic beverages. Core inflation was 5.7%, down from 6.1% in September. Annual wage growth continued to grow but at a slower pace compared to recent figures. Excluding bonuses, annual wages grew 7.3% while including bonuses, pay increased by 7.2%. With inflation at 4.6% (according to the most recent data release relating to October), the average wage increase implies real wage growth for employees which should also support credit quality. Between August and October 2023, average regular pay growth for the public sector was 6.9%, marking one of the highest annual growth rates since record keeping commenced in 2001. Meanwhile, private wage growth was 7.3% in the same period.

In Exhibit 2, we show GDP growth, CPI and unemployment forecasts for 2023 collected by HM Treasury and released on a monthly basis. Analysing HM Treasury’s November release, we find that, compared to October’s release, both GDP growth and inflation estimates for 2023 have ticked up by 0.1pp to 0.5% and 4.6% respectively, while unemployment rate expectations are left unchanged at 4.4%. Average forecasts for GDP growth, unemployment and inflation are now 0.5%, 4.3% and 4.6% respectively versus the average forecasts of 0.5%, 4.4% and 4.5% released in October (see Exhibit 3).

The 2024 forecasts collected in November remain broadly in line with the October assumptions (see Exhibit 3). GDP growth expectations remained unchanged whilst unemployment rate expectations increased 0.1pp to 4.7% and inflation expectations rose 0.2pp to 2.7%. In the forthcoming data release, we anticipate a downward revision in 2024 GDP forecasts as recent GDP data revealed that the UK economy shrank by 0.3% between September and October.

Exhibit 4 shows the consumer confidence indicator of personal finances and the economic outlook between now and the next 12 months.

The overall index score is made up of five measures: personal finance situation (over the last 12 months), personal finance situation (over the next 12 months), general economic situation (over the last 12 months), general economic situation (over the next 12 months) and the Major Purchase Index. All five measures improved from the October data. Positive sentiment can be attributed to falling inflation and real wage growth in both the private and public sector. Falling oil prices have also been a tailwind to the more positive outlook. Supporting this view, a Bank of England (BoE) survey found that average expectations among the British public for the rate of inflation over the next 12 months fell to 3.3% in November, down from 3.6% in August. However, we do note that over the past few months sentiment seems to be range-bound, which suggests that consumers remain uncertain about the outlook.

Unemployment continues to climb gradually as we move into a higher real interest rate environment (see Exhibit 5). Unemployment rose 0.1pp m-o-m and 0.5pp y-o-y. Redundancies followed a similar trend, with 102,000 people made redundant based on data for July. This was lower than the 108,000 reported in the previous month but 59% higher year-on-year. Per 1,000 employees, redundancies were 3.6, up from 2.3 in 2022. We expect this trend to prevail as the BoE works towards its inflation target.

Exhibit 6 illustrates the value of advances and number of used cars that were purchased on finance through dealerships. In data stretching to October 2023, on a year-on-year basis, the value of used cars dropped 5% to £1,831 accompanied by a 4% drop in the volume of cars to 123,390. Despite the decrease in both value and volume, compared to previous years the figures remain elevated even in the face of an unfavourable economic outlook.

Exhibit 7 shows the number of monthly used car transactions in the UK between 2020 and 2023. In September, monthly volumes dropped 7% month-on-month, which can be attributed to seasonal factors as declines in September are apparent in all the preceding years to 2014. However, we note that in the last four years the 7% fall is the second largest decrease, beaten by a decline of 8% in 2022. We do highlight that month-on-month transactions in 2023 year to date have been consistently above those in 2022. In the nine months to September, average monthly transactions were 618,175, ranking third lowest (2022: 591,054; 2020: 562,202) out of data compiled from 2014. With rate rises slowly having its effect on the economy, we could see further suppressed monthly transactions – in addition to the usual seasonal slowdown – as consumers opt out from purchasing cars.

Exhibits 8 and 9 show that used car prices are headed downwards. According to data collected by the Office for National Statistics (ONS) to October 2023, the used car price index fell 3% m-o-m and 4% y-o-y (see Exhibit 8). At a value of 115, the index has fallen below its previous resistance of c 120 which, coupled with the subdued economic outlook, could serve as an indicator that used car prices are headed further down in the short term. Exhibit 9 shows the month-on-month changes in the price of used cars. Since June 2023, ONS has recorded consecutive negative month-on-month price changes in the values of used vehicles, on a par with the consecutive negative moves seen between February 2022 and June 2022.

Exhibit 10 illustrates both non-residential and residential transactions (seasonally adjusted figures) in the UK, with the latter more appropriate for Aspen. Compared to residential transactions, non-residential transactions are holding up well. Year-on-year, non-residential transactions stayed relatively flat but increased 3% m-o-m to 9,930 (provisional estimate). However, residential transactions fell 21% y-o-y and 3% m-o-m to 82,910 (provisional estimate). This effect is highlighted in Exhibit 11 where data from the BoE shows that monthly mortgage approvals have stumbled to levels not seen since 2010. As interest rates have climbed steeply, lenders have subsequently passed on rates to consumers while simultaneously tightening credit standards, making it harder for first time buyers to get onto the property ladder.

The pressure of higher rates is beginning to surface. Mortgage data published by the BoE on 12 December revealed that arrears, as a proportion of total loan balances, increased quarter-on-quarter to 1.17% from 1.02%, the highest since Q217 (see Exhibit 12). Although historically the figure is still low, the uptick highlights the burden that higher rates and inflation are placing on households and the increasing difficulty to meet mortgage payments.

Aspen’s business model of providing property bridging financing to sophisticated landlords and developers may partly mitigate the issue of rising arrears. On the one hand, due to its short-term lending structure, Aspen can respond promptly to market changes and adjust its lending criteria to suit prevailing market conditions. However, it can also be argued that since the loan terms are short (11-month average term in H123), developers will also need to find buyers in the short term. If they are unable to achieve this, Aspen may experience some difficulties with its clients’ ability to repay loans. Thus far, however, Aspen has stated that in the past four months repayments have been 20% above budget and it continues to experience strong momentum in the business, with the pipeline of new business at a record level and 30% above budget. We note that collections remain robust and the number of loans in technical default is 16, compared to 15 in H123.