This is not investment advice. Do your own research before taking a position in any of the securities mentioned in the post below.
Non-bank lenders & this two-part article on LFG
Whilst it is assumed that most Aussie stock portfolios include the Big 4 banks, there is some validity in considering non-bank lenders since regulation, technology & governance limitations make it hard to for these encumbents to grow.
Without getting too carried away with the whole "neo-bank" theme; investing in these players requires a greater understanding of the underlying company & loan book than you do if you throw some $ into CBA. There is nothing wrong with putting $ in the Big 4 & forgetting about it, however, it is worth noting that collectively the Big 4 may lose market share over time.
In terms of Liberty Financial Group (LFG), since it is a sort-of complicated business and unfortunately because it is a recent IPO the prospectus is one of the larger sources of this article. I am going to cover LFG over two articles.
Overview of the business and risk/return
Conclusion & valuation
NB If this non-bank lending space really interests you - Morgans do a decent podcast on it.
Overview of LFG
LFG was established in 1997 by Sherman Ma & Greg Parseghian, with an initial focus on the Australian residential mortgage sector. Over time, LFG has moved into motor finance, commercial mortgages, personal loans, business loans, broking services, general insurance and real estate services in Australia & NZ.
It IPO'd in Dec'20 and generally is thinly traded with limited free float
The reason why I think LFG is worth considering is that their loan book is broader than most other non-deposity taking lenders & their low exposure to personal loans. It is not unreasonable to assume the beloved Aus resi mortgage growth rate slows... so ideally you want to pick a lender which has some other sources of loan growth. If mortgages slow; LFG has a pre-established commercial, SMSF, auto and aggregating products which can keep revenues growing
Non-conforming loans - but isnt that what made the GFC??
Part of the reason for LFG's growth is commercial lending, however, it has also been getting loan growth from borrowers which do not fit the usual Big 4 borrowing criteria- non-conforming (NC) loans.
To be clear, NC loans often require LFG to move up the risk curve to compete with Big 4 & just so you are aware - in downturns NC perform worse (e.g. 15% were paid late in Mar'08 vs. 3-4% for prime loans).
Whilst this is part of LFG book, it is not a significant component. Below are reasons why I personally consider that risk to be reasonable
1) LFG's loans made <3% losses since 2000 2) Loss pre LMI Claim are low vs. Peers
3) Overall LVRs are generally <80% 4) Majority of their mortgages are full doc
5) 89% of their commercial loans are prime 6) Riskiest stuff is fixed rate motor finance
So my point here is - LFG’s made a name for itself in the NC space, however, the majority of their residential and commercial loans are prime loans. In fact - the riskiest part of their book is the fixed rate auto book which is a relatively small but growing % of their book
Competitive landscape
Before you get bogged down in the all the different types of lending, duration & default rates... remember that there is plenty of competition in this space and the Big 4 compete in almost all of these product types. Below is how I like consider the main competitors for LFG in each of the below categories
One of the quicker ways in which LFG can grow is via acquisition, as they have done historically, and indeed this was the rationale for the IPO (or so they say)
It is unfortunate that they were not successful in the acquisition of Westpac auto loan book which was acquired by Angle, because these transactions do not arise all the time.
Below is LFG's historical growth rate in lending
LFG is not a leader in any product type so investing in LFG it is essentially a bet on them obtaining a larger portion of the lending market as opposed to to a bet on the overall loan market growing.
Risks - Leverage is high & limited defaults are priced in today
Leverage: the biggest risk for LFG is its leverage factor compounding the loss given default. Whilst you may say - "of course its levered; its a lender" . Well, it is levered at 13x vs. 4-5x for the big 4 AU banks. This leverage is less than Resimac, AFG and Plenti however it does increase their risk.
Dilutive M&A: I covered it before however they will likely have to acquire growth which carries its usual risks
NC loans: I covered it above, however, these are by nature riskier than regular loans, worse still an investment today is buying at a point where defaults are low
Reputation (product): Like Plenti/Pepper, you only need to google LFG to see a raft of bad consumer loan reviews. Their product reviews/home loan reviews are strong. However, brand value is important in lending where $'s are a commodity.
Reputation (founders): Whilst Sherman is no longer the CEO, he is a driving force behind the company. Most comments on the ethics of the company have been usual journo gossip however I consider reputational risk higher for LFG than a Big 4.
Reward - A rare example of a non-bank with wholesale funding & a founder-led business
Founder led business: Current management own +50% of the shares outstanding and 25% owned by two original founders who no longer actively work for LFG
Access to wholesale market: LFG is one of the only Australian non-banks with access to the wholesale market
Survived the 2008 crisis: Alot of the neo banks have <20 years history and as such have not had to react to a full financial crisis
Breadth of products: stated above
Conclusion - I will run a more fullsome valuation in the coming posts, however, the key takeaway is that LFG is a highly-levered, founder-run lender with fairly uniquely has access to the wholesale market. I think the overall exposure to NC loans is a possible reason for concern, however, this risk is partially offset by the breadth of service offerings that LFG has built out over its 25yrs of operation.
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