An investors view:A combination of reasonable credit quality and higher profit margins makes the sub-prime mortgage market attractive for providers such as Fire and Start
The tiny IEX listed Finance Ireland (market capitalisation € 15.5m) announced its audited financial results for the six months ended December 2006 on Monday. The company is changing its financial year-end to December from June which explains the "short" accounting year.
Finance Ireland (Fire), formerly Ardent, is the holding company for Shared Home Investment Plan (Ship), which is a leading Irish provider of equity release products to the over-60s. This is a relatively new market, but likely to achieve sustained growth over the long term as the population ages and as more over-60s seek to release equity from their family homes.
Fire offers both lifetime mortgages, where it competes with the large banks, and home reversion plans where it advances a loan in return for an equity stake in the property.
Lifetime mortgage loans totalled € 26.2 million at end-December 2006 and the net book value of home reversion interests amounted to € 7.4 million. For the "short year" lifetime mortgages generated gross interest income of €557,000.
The products are marketed through 180 mortgage intermediaries, all of whom are authorised by the Irish Financial Services Regulatory Authority. The Home Reversion portfolio now has interests in a total of 102 properties.
In early April this year, a joint venture with Investec, a South African company, called Nua Homeloans, began offering mortgages in the non-standard or sub-prime mortgage market.
The sub-prime market in Ireland is underdeveloped and the market is dominated by Start, a subsidiary of the British listed Kensington Group, and a joint venture between GE Money and IFG Group. Irish Life & Permanent has announced its intention to enter this market with Merrill Lynch.
Current estimates put the Irish sub-prime market at just under €1billion, with expectations that it could grow to € 3 billion plus within a few years. With the total Irish mortgage market standing at € 41 billion the sub-prime market represents only 2 per cent of the total.
However, given the small size of Fire, even a modest share of this market would have a material impact on its growth prospects.
The sub-prime market clearly involves a higher risk of customer arrears and default compared with the traditional mortgage market. These mortgages are typically taken out by consumers who experience problems in getting a mortgage from traditional banks. In some cases this is due to poor credit histories, but in many cases it is due to a variety of other factors. For example, someone who has recently become self-employed may have difficulty in getting a mortgage loan.
Therefore, the overall credit quality of sub-prime mortgages may well be much stronger than it may appear at first sight.
A combination of reasonable credit quality and higher profit margins makes this an attractive market for providers. Start achieved interest spreads of 360 basis points over Euribor in 2006 compared with spreads of approximately 100 basis points for traditional mortgages and it also enjoyed rapid growth in advances in 2006.
Fire is tiny with balance sheet assets of € 45 million and it is not yet profitable - losses per share were one cent in the six months to end-December. However it is operating in a profitable and growing market niche. If it can achieve a significant market share in its chosen niches over the next three-five years, its shares have the potential to rise substantially. The big risk is that it will not achieve sufficient scale in time to enable it to compete with the entrance of new and bigger players to the market.
IFG Group, the other Irish quoted player in this space is much larger with a market capitalisation of € 140 million and it offers a much wider range of products and services. Its principal activities are the provision of independent financial advisory services in Ireland and Britain, mortgage business solutions and title insurance services in Ireland, and the provision of international and corporate trustee services.
After a difficult period in 2003/04, profits recovered sharply in 2006 when it made pre-tax profits of € 12.6 million. Brokers are forecasting further strong growth to pre-tax profits of over € 17 million for 2007, which translates to earnings per share of 18 cent putting the shares on a prospective 2007 price earnings ratio of 11.4.
The recovery in profits is probably now reflected in the share price and performance from here will depend on how well it executes its strategy across its range of businesses, including its push into the sub-prime mortgage market.
