I note with interest the second profits warning today from Provident Financial. It seems like an almighty mess with a corporate restructuring in its core business of door step credit tripping the business into disaster. I don’t know the business well enough to give any insight but many bitter years of experience suggests that

  1. Profit warnings usually come in three’s which implies that a new boss will grab for that kitchen sink and reveal all the true nasties from the previous management
  2. The short sellers have made an absolute fortune but sooner or later this will unwind and we might see a bounce back in the share price. Quite how long that takes is anyone’s guess
  3. The retail bonds have taken an absolute hammering

I want to focus on the last observation – what the heck has gone wrong with the retail bonds. I note that PF17, due to mature on the 4th October, are trading down at £94.55 on a maturity value of £100. Meanwhile the obviously more risky PF21, maturity date 2021 with a coupon at 6%, is trading down a whopping 30% plus per cent. The current price is at £68.25.

Of course we shouldn’t be surprised by this development in the retail bonds. Ordinary retail investors will have seen the carnage in the share price and thought “hell, let’s sell those 6% bonds maturing in 4 years time straight away”. I could also throw in ‘ no smoke without fire” and profit warnings come in threes!!

But a basic look at the business suggests a possible over reaction. As I said I am no expert on this sub prime lender. But its current market cap is at around £660m versus group net assets of £731m – although that figure was before today’s not completely shocking profits warning. We could I suppose see a run on the successful Vanquis Bank bit of the empire but this seems to be solidly profitable and kicked in PBT of £100m at the interims – the profits warning did come with news that a supplementary product sold by the bank was being suspended. Moneybarn also seems to be trading solidly.

So, common sense, currently suggests that although the equity shareholders could be wiped out, bond holders MIGHT be safe. There’s still alot of capital to eat through. My guess is also that the banking covenants will very soon be triggered and there’ll be some searching discussions with the lenders – rather on the model of Premier Oil.

So, it seems to me, at this initial stage, that there might be an over reaction in terms of the retail bond prices. The most obvious one would be PF17 due any time now. It could I suppose fail to mature in just two months but if that was to happen, I assume we’d be looking at corporate bankruptcy. If that is the case then investors might get a nice 5% bounce.

Obviously with the longer dated PF21 issue – maturing in 2021 with a 6% yield – there’s a lot more work that needs to be done in terms of research into the balance sheet. 60p in the £1 looks about right for what is now clearly a junk bond but I also think there might be some upside if the new management gets their act together and fixes their broken internal systems. If the retail bonds do pay out in full in 2021 – a big if given the pricing – then we’re looking at yield to maturity of 17.5% and running yield of 8.7%.