By Leo Sek – Clime Asset Management
FSA Group Limited (ASX:FSA) provides financial restructuring services to individuals and businesses who are unable to meet debt repayments or who require short term finance but are unable to obtain this from commercial banks.
FSA is the market leader in administering personal debt agreements and broking non-conforming mortgages in Australia. A debt agreement is a negotiated compromise between the debtor and creditor. The agreement may include repayment of less than the full amount of debt owing or a moratorium on repayment of debts.
The company operates through three divisions:
• Personal debt arrangement representing 76% of EBT
• Direct lending 23% of EBT
• Business debt arrangement 1% of EBT
(a) Personal debt arrangement
FSA’s subsidiary Fox Symes provides a range of services to financially distressed individuals including:
• budgeting assistance
• arrangement of third party consolidation loans and mortgage finance
• debt agreements
• personal insolvency agreements
• bankruptcy assistance
The Australian personal insolvency industry is mature, growing at 4% per annum in the 10 years to 2009.
Source: FSA Group Ltd FY2009 annual report
Fox Symes is the market leader in administering debt agreements with a 54% market share as shown below.
Fox Symes market share of debt agreements. Source: FSA Group Limited FY 2009 annual report
Fox Symes earns a fee from the creditor for administering the debt agreement. Fees are taken proportionately over the life of the agreement.
(b) Direct lending
This business started through the acquisition of a $2.1 million short term bridging finance portfolio as part of the purchase of the 180 Group in April 2006.
FSA has grown its short term bridging finance portfolio and introduced factoring finance and non conforming mortgages as shown below.
Source: FSA Group Ltd annual reports
The loan portfolios are financed by Westpac through the following facilities.
FSA’s non conforming mortgages are of higher quality than their competitors as highlighted in the diagram below.
Source: FSA Group Limited FY 2009 annual report
(c) Business debt arrangement
This division commenced with the acquisition of the 180 Group.
180 Group provides services businesses in financial difficulty through:
• strategic planning
• informal creditor arrangements
• equity investment and arrangement of third party equity investment
• advising on business sale
Similar to Fox Symes, 180 Group earns a fee for providing these services.
Key investment issues
The Direct Lending division is currently funded by Westpac only. This gives Westpac significant bargaining power over FSA in terms of pricing and dependency for funding. The non-conforming mortgage facility is reviewed annually, increasing the risk of funding being withdrawn.
However, FSA is conservatively geared with forecast FY 2010 debt to equity of five times. FSA has capacity to take on more debt to grow its loan portfolio. The board’s policy of retaining all profit increases the level of equity in the business and FSA’s ability to increase its financial leverage.
On 1 July 2007, changes were made to the Debt Agreement Legislation resulting in the lowest number of debt agreements administered in the three years to July 2007. It took six weeks to adapt to the new legislation and volumes returned to normal volumes in late August 2007. Future legislative changes may pose similar disruptions to FSA’s debt agreement administration business.
Insufficient staff to service debt agreements
The work involved in managing debt agreements requires a high level of personal interaction and negotiations between all the parties involved.
As management plans to increase market share from 54% to 60% by FY 2013, FSA will need to hire more staff to service the growing number of clients.
FSA is a tightly held company with the directors and key management owning approximately 44% of issued ordinary shares. Daily trading volume is approximately 100,000 shares.
The risk is if investors need to dispose FSA shares in a hurry, they may not be able to do so without realising potentially large losses.
Over the past four years, profit grew each year and return on equity (ROE) maintained above 40%, with the exception of FY 2008. FY 2008 was affected by one off costs to establish the non-conforming mortgages business and to change IT platforms in response to legislative changes.
The reason for the strong ROE performance is due to FSA’s ability to generate a high return on incremental equity:
• profit rose from $2.6 million in FY 2006 to forecast $10.6 million in FY 2010
• FSA retained $31.2 million of profit and raised $7.8 million of new equity
• this produced a return on incremental equity of 20.5%
This is a characteristic of a good business, the retaining of profit while the business generates a high return on incremental equity.
There is little prospect for growth in the personal debt agreement business as FSA has been the market leader for the past five years and the Australian personal insolvency industry grew at a modest 4% per annum.
We expect growth to come from the non-conforming mortgages business. This business is highly scalable and faces little competition from commercial banks and non bank lenders. With the Australian economy gradually recovering, conditions are positive for credit growth and FSA will enjoy first mover advantages in this segment.
We have adopted a required return of 16.1%, which is appropriate given the small market capitalisation of FSA and the growth stage of its non conforming mortgages business.
The adopted profitability forecast of 30% is conservative given how quickly the non conforming mortgages business should grow. The market requires 17% profitability to justify the current price.
Therefore, FSA have some attraction at current market prices for investors with a higher risk profile.
Clime Asset Management uses StockVal.
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