Provident Financial is a very successful doorstep lender. Its 11,500 strong army of self-employed commission-based agents target individuals who would struggle to get credit via more conventional means, such as banks or credit cards.
The loans, typically £300 - £500 for up to a year, are unsecured meaning the company is especially vulnerable to bad debts. However, Provident Financial charges customers very high rates of interest; the typical APR is 254.5% - 272.7%. With such a massive margin it can afford to pay agent commissions and incur some bad debts while still making handsome profits – something it's achieved consistently in recent years.
Provident Financial also offers a credit card through its Vanquis Bank operation, which typically charges 39.9% APR.
The company is listed on the London Stock Exchange and its share price has been fairly resilient over the last few years relative to overall market volatility. However, the price dipped in early March this year when Provident Financial announced lower than expected profits and warned of tougher times ahead. Nevertheless, it's likely to remain profitable and the dividend yield is currently attractive at around 7.3%. Invesco and Schroders own around 40% of the share capital between them.
While there is a moral issue over supporting a company that charges the financially vulnerable such high rates of interest, there's little doubt that this is a profitable business model that has so far weathered the economic downturn well.
I think the biggest threat to profitability remains bad debts. Provident Financial's 2009 accounts show an impairment charge (effectively bad debts) over the year of £283.4 million, a 19% increase on 2008. Given Provident Financial has around £1.14 billion of outstanding customer loans then bad debt provision appears to be running at about 25%.
So, against this backdrop, is Provident Financial's 7% 2020 corporate bond worthwhile?
If you buy the bond and intend to hold it for the full 10 years until maturity, then I think there's a reasonably good chance of getting your money back plus all the interest payments meanwhile. But I certainly wouldn't take this as a given. As highlighted above, the business makes money by borrowing cheaply (in this case, at 7% plus commissions) and lending at sky high rates able to absorb relatively high levels of bad debts. If bad debts rise to unsustainable levels or future legislation restricts the amount of interest that can be charged, then profitability (hence bond payments) could come under severe pressure.
The credit rating agency, Fitch Ratings, rates Provident Financial as BBB+. This is classed as 'lower medium quality' – the BBB category is one notch above non-investment grade (or junk) bonds.
You can expect to receive income payments of £35 per £1,000 invested on 14 April and 14 October each year.
If you sell before the redemption date you may make a profit or loss on your original investment. The factors most likely to influence the bond price are interest rates, inflation and Provident Financial's financial strength. Rising interest rates and/or inflation will likely cause the bond price to fall, as would deterioration in Provident Financial's financial position.
How does the 7% yield compare to other bonds in the marketplace?
Provident Financial issued £250 million of 8% 2019 bonds to the institutional market in October 2009, currently yielding around 7.3% gross to redemption. The 7% yield on this new issue looks a bit stingy by comparison (perhaps because Provident Financial is, unusually, paying a 0.5% tail commission to the broker distributing the bond).
Otherwise, the yield looks reasonable versus similarly rated companies – for example, Severn Trent Water (rated BBB+ by S&P) 2024 6.125% bonds have a current gross redemption yield of about 5.5%.
I don't think the Provident Financial 7% 2020 bond is a bad deal if you're prepared to sit tight for 10 years and don't anticipate higher inflation (means your money will purchase less when you get it back in 10 year's time) and/or interest rates (means you might end up getting higher rates in the bank).
But personally I wouldn't take the risk when bank savings accounts are offering up to 5% gross fixed for five years. Plus I'd always be wary of investing in a single corporate bond. Better to spread your money across several, perhaps using a fund to do so.
Regardless of the outcome, there will almost certainly be one winner in all this – Hargreaves Lansdown - the broker selling the bond. Provident Financial will, unusually for a corporate bond, pay Hargreaves Lansdown up to 0.5% a year on the principal amount of the bonds in issue until redemption in 2020. Maybe that's why Hargreaves Lansdown has sent me several emails in as many weeks encouraging me to invest!
You can read more about fixed interest investing in our investment section here.
Read the full review at http://www.candidmoney.com/candidreviews/review21.aspx
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