Avanti Finance – 4NC2 AUD Bond

The issuer is rated BB (S&P) and the bonds are senior secured. Price guidance is 9% (fixed) and 3mBBSW+5% (floating) which is fair value for new investors. For investors looking to take a little more risk, the Liberty 26s and Liberty 27s would be ideal switch candidates. In relation to the investor decision to go fixed or floating, the running yield would be 9% (fixed) and 7.9% (floating) [based on issue margin of 5% plus 3mBBSW of 2.9%].

Avanti is the second largest non-bank lender in NZ (by assets). NZ are further ahead in the cash rate hike cycle than AU. However, Avanti have appeared to manage quite well with bad debts falling. While the bulk of the book is still comprised of borrowers who find it difficult to get funding from the traditional banks – it shows their origination process is robust and rigorous – especially given the weighting towards near-prime mortgages.

Avanti is benefitting from being a non-bank and not subject to the same limitations as the regulated banks within their lending book. As this industry continues to be less appealing to traditional banks, non-bank lenders are expanding and growing market share. The main weakness for Avanti would be their funding channel and reliance on bank warehouse structures – albeit, we would acknowledge their shareholders have been strong in their support during challenging times and this bond issue is a positive. On NZ house prices and economic conditions – we are comforted by the stress tests Avanti has undertaken on its residential mortgage book recently.

The stress test assumed that borrowers defaulted when LVRs >100%, that subsequently the property for which the default occurred is sold within a month, at a loss and that the losses are first absorbed by excess spread in funding vehicles, then waterfalled across notes seniority, with the most junior notes absorbing losses first. Under these assumptions – the equity of Avanti, but not the A-MTNs themselves (given overcollateralization and seniority) would start to be affected after a 25% drop in NZ house prices. A dramatic 35-40% fall in house prices would start to see material losses incurred to Avanti equity – but not the A-MTNs themselves again.

Key Highlights:

• $2.1b receivables as at June 22, up from $1.5b in June 21 – 34% increase
• 56% Mortgages, 34% Auto, 10% personal and business – book skewing towards prime customers
• $35m NPAT as at June 22, up from $30m in June 21 – 17% increase
• 2% NIM as at June 22, down from 5.1% in June 21 as book credit quality improves
• Arrears fell during 2020 (Covid), and have maintained lower levels since
• Credit Losses at $8.4m (41bps) for June 22 year compared with $11.8m (79bps) for June 21 year – higher quality book
• ROE at 16% in June 22 year from 17% in June 21 year
• Strongly capitalised at 16.8% risk adjusted capital (S&P calculation) at June 22
• ‘BB’ Stable credit rating

Avanti currently have 3 bonds outstanding and have been a regular issuer in AUD. The Sub-IG Band / Unrated Curve would imply a trading margin of 5.75%. However, Avanti has typically priced inside this curve, as seen below. Given Avanti is an inevitably a better credit versus the opportunity set, we believe the price guidance of 5% is fair value.

Source: BondAdviser

Furthermore, for investors looking to take a little more risk, the pickup from the Liberty (BBB-) curve to Avanti (BB) is around 100bps. Liberty bonds are unsecured versus Avanti which are secured. Taking these security considerations into account, the two-notch differential of 100bps between respective curves would be a fair outcome for a switch trade.

Source: BondAdviser

Avanti is compliant with all financial covenants in respect of the bonds. Currently, it holds an excess of $118.7m above the required $100m in shareholders’ funds and an ICR of 7.60x, above the 2.0x covenant minimum.