Provident Financial: Dropped NSF Bid Removes Uncertainty; Challenges Remain

Provident Financial Holdings

07/06/2019 12:05

(The following statement was released by the rating agency)


Fitch Ratings-London-June 07: Non-Standard Finance plc's (NSF) decision 
announced on 4 June to abandon its takeover bid for Provident Financial Plc's 
(Provident; BBB-; Negative) removes immediate uncertainty about Provident's 
business strategy and financial policies, Fitch Ratings says. 

The decision is moderately positive for Provident's credit profile. However, 
defending itself against the hostile takeover bid came at a financial cost and 
distracted management.  

Fitch understands that NSF abandoned its bid for Provident because of a 
potential capital shortage in the combined entity due to the anticipated 
material minority interests. According to the UK takeover code, NSF now has to 
refrain for at least 12 months from presenting another bid for Provident.

We see the cancellation of the bid as moderately credit-positive because it has 
put an end to the standoff between NSF and Provident, which was consuming 
significant management time. The cost of defending against the bid was 
significant and will be recorded as an exceptional expense in 1H19. Provident 
estimates this cost to be around GBP20 million (22% of 2018 pre-tax income).

The Negative Outlook on Provident's Long-Term Issuer Default Rating reflects our 
view that Provident's ratings would be downgraded if the recovery in its home 
credit business is insufficiently quick to restore a sound degree of earnings 
diversification, which has historically underpinned Provident's credit profile. 
A set of measures to recover performance includes the reintroduction of a 
variable component to the compensation of home credit staff (approved by 
regulator), better controls of the sales process and digitalisation. Provident's 
ratings would be under pressure if these measures do not lead to increased 
improvement in the performance of the home credit business through a meaningful 
improvement in collection rates and lending volumes (and thus profitability). 
Fitch could revise the Outlook to Stable if Provident improves revenue 
diversification via material strengthening of profitability in the home credit 
division.

The company is less cash-generative as Provident's home credit business is now 
smaller. As a result, Fitch believes that Provident's current business model and 
revenue mix cannot support as high a leverage level as before the operating 
model change. Any material and sustained increase in leverage (from its gross 
debt/equity multiple of 3x at end-2018) could, therefore, trigger a downgrade.

Failure to maintain an adequate surplus capital buffer above the regulatory 
minimum (for instance as a result of an unexpected loss) or reduced access to 
funding, could also lead to a downgrade. A large decrease in Provident's 
non-performing loan reserve coverage ratio would also be rating-negative.

We do not expect a significant immediate effect from developments related to the 
UK's Brexit vote on Provident. This is due to its domestically focused business 
model with only limited exposure (around 2% of total receivables at end-2018) to 
home-collected credit in Ireland. However, more prolonged negative macroeconomic 
consequences, notably weaker employment metrics, would affect Provident's 
performance and could be rating-negative.

The company's long-established consumer credit division is subject to an ongoing 
turnaround plan. The business line lost scale benefits and saw weak collections 
performance during the operating model change in 2017. It also incurred 
increased fixed overheads as staffing moved away from the use of self-employed 
agents to the engagement of employees. Provident's consumer credit division 
business remains the largest in its field in the UK, despite the fall in its 
customer base to 560,000 by end-2018 (2017: 780,000, 2016: 862,000). In November 
2018, it obtained full regulatory authorisation from the Financial Conduct 
Authority (FCA). The segment's performance gradually improved through 2018 but 
remained in negative territory with total revenue contracting 29% yoy and 
remained below historical levels. 

Provident's other businesses, Vanquis Bank and Moneybarn, remained profitable in 
2018. Vanquis is currently the main source of pre-tax profit (GBP184 million). A 
refund on the Repayment Option Plan product agreed with the regulator is now 
completed. Management indicates it kept related costs within the GBP49 million 
provision held as of end-2018. 

Moneybarn (18% of pre-exceptional pre-tax profit) demonstrated solid growth in 
terms of customers and revenue (24%) despite weaker efficiency and higher 
impairment costs (partially driven by IFRS 9 adoption). Management expects the 
financial impact from the conclusion of the FCA investigation to be contained to 
a GBP9 million provision allocated as of end-2018. 

The regulatory environment for the UK's non-bank financial institutions industry 
has evolved significantly in recent years, reflecting the additional costs of 
regulatory compliance by lenders. This also reflects FCA's focus on the 
appropriate business model and scale dynamics for this sector. Closer regulatory 
scrutiny is visible in multiple areas, including the regulatory enquiries and 
associated exceptional costs incurred by Provident in 2017. This also includes 
the subsequent increase in Vanquis's capital requirement and heightened 
attention across all segments to ensure accurate affordability assessments and 
fair treatment of customers in persistent debt. A bank licence provides an 
additional funding channel but increased regulatory oversight across the various 
businesses has moderated returns and the associated cost of governance will be 
ongoing.

Provident plans to announce 1H19 results on 30 July 2019. 

Contact: 

Aslan Tavitov

Senior Director

+44 20 3530 1788

Fitch Ratings Limited

30 North Colonnade

London E14 5GN

Christian Kuendig

Senior Director

+44 20 3530 1399

Media Relations: Louisa Williams, London, Tel: +44 20 3530 2452, Email: 
louisa.williams@fitchratings.com.

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