Liberty Financial FY22 - a ratings upgrade candidate in the making / should outperform
Liberty Financial is a specialty finance provider and one of the first non-bank financial institutions (NBFI) to be formed in Australia in 1997. The company is listed on the ASX with a market capitalisation of AUD1.3bn (as of 6th Dec 2022) and total assets of AUD14.3bn (as of last reporting period). Liberty operates across three main segments being residential finance, secured finance and financial services.
Liberty Financial has 5 bonds outstanding in the AUD bond market.
Source: Bloomberg
Why do we like the Liberty Credit?
- Liberty is not regulated by APRA and thus not required to maintain prescribed capital ratios. Nonetheless, Liberty maintains above what is needed for S&P as per their risk-adjusted capital (RAC) ratio. Currently, Liberty has a RAC ratio above 15%.
- Liberty reported a profit of AUD219mn for FY22 (up 18% on pcp), driven by the economic rebound post COVID-19 and consistent low loss performance.
- Liberty’s asset quality metrics are strong given its focus on prime borrowers (i.e., lower risk) within the residential mortgage space. Bad and doubtful debt (BDD) charges were 0bps (0bps on pcp) for FY22 with credit losses (provisions) coverage at 8x.
- Liberty’s loan growth should continue to grow as APRA tightens lending standards for banks. The company reported 36% growth in new loans to AUD5.6bn and at the same time reported a stable net interest margin (NIM) of 3.08% (3.08% on pcp) in contrast to industry margin decline.
- Liberty’s funding growth has been supported by seven new funding vehicles in FY22 totalling AUD5bn in new liquidity.
S&P BBB- rating positive outlook = S&P placed Liberty’s outlook on positive in April 2021 and they usually resolve a positive action within 24 months [so by April 2023]. The positive outlook reflects a one-in-three chance of upgrade if S&P’s view on Australian financial institutions industry risks decrease in the next two years.
In relation to what is in Liberty’s favour for an upgrade to BBB (from BBB-) within the next 12 months.
- Liberty has a strong focus on prime borrowers within the residential mortgage space. BDD charges have been well below industry levels, and this shows how well Liberty is doing in a tough environment. S&P will also view the credit losses (provision) coverage at 8x as more than ample.
- Liberty’s loan growth and risk management framework has held up well during the current economic cycle.
- Liberty is running an S&P RAC ratio above what is required which means there is a buffer to absorb losses (if they arise).
What could change this = higher funding costs will impact their NIM, so it is important Liberty continues to maintain good access for its securitised and warehouse facilities. We will potentially be reaching the terminal cash rate / end of cash rate hikes in mid-2023 and so S&P would analyse the company’s situation at that point in time.
What are the Risks?
- Asset quality issues. Although, we note that Liberty’s asset quality metrics have been strong.
- Liberty is not regulated by APRA and so there is an argument that its risk management framework may not be as strong as banks.
- As a NBFI, Liberty is reliant on wholesale funding as it does not have a deposit base like other banks. Higher cost of funds will impact their NIM.
Where is the best Relative Value for Investors?
As noted above, Liberty Financial has 5 bonds outstanding in the AUD market. One positive for bondholders is that Liberty bonds are issued from the OpCo and not the HoldCo. While Liberty does utilise secured warehouses in its funding base, the OpCo structure is generally preferred for credit investors
In our opinion, the Liberty 27s offer the best relative value versus the investment-grade, floating rate opportunity set. There is also relative value switching from short-dated major bank subordinated paper to Liberty nonbank senior unsecured paper for clients worried about extension risk on those securities.
Financial Statistics – FY22
| FY22 | FY21 | Movement | |
|---|---|---|---|
| Statutory NPAT1 | $219.3m | $185.4m | +18% |
| Underlying NPATA2 | $231.1m | $226.1m | +2% |
| Return on financial assets3 | $12.9b | 12.2b | +6% |
| Return on Financial Assets3 | 1.7% | 1.7% | Stable |
| Return on Equity3 | 20.4% | 20.0%% | +2% |
| Leveraged Ratio (end of period) | 12.8x | 13.2x | -3% |
1 – Net Profit after tax
2 – Net profit after tax and amortisation where ‘underlying’ means ‘Pro-forma’ in the prospectus
3 – Uses underlying net profit after tax and average year end balances
Source: ASX LFG
The leverage ratio is total assets / total equity
Source: ASX and IAM CM
| Key Financials | Actuals | Market Estimates | ||||
|---|---|---|---|---|---|---|
| 31/12/2019 | 31/12/2020 | 31/12/2021 | 31/12/2022 | 31/12/2023 | 31/12/2024 | |
| Income Statement | ||||||
| Total Revenue | 292.9 | 523.5 | 645.9 | 1,110.5 | 1,606.3 | 1,839.3 |
| Growth Over Prior Year | 2,061.3% | 78.7% | 23.4% | 71.9% | 44.6% | 14.5% |
| EBITDA | 115.9 | 194.5 | 230.0 | 381.8 | 627.8 | 755.0 |
| Margin % | 39.6% | 37.1% | 35.6% | 34.4% | 39.1% | 41.0% |
| Period on Period Change | (7,549.3%) | 67.8% | 18.3% | |||
| EBIT | 90.2 | 157.7 | 194.0 | 349.3 | 574.9 | 689.3 |
| Margin % | 30.8% | 30.1% | 30.0% | 31.5% | 35.8% | 37.5% |
| Pre tax Profit | 164.6 | 154.6 | 181.0 | 329.2 | 557.5 | 701.3 |
| Net Income | 124.0 | 110.6 | 137.9 | 244.8 | 390.1 | 492.0 |
| Cash Flows | ||||||
| EBITDA | 115.9 | 194.5 | 230.0 | 381.8 | 627.8 | 755.0 |
| Funds from Operations | 191.1 | 484.5 | 19.4 | |||
| Change in Working Capital | 147.9 | 334.5 | (169.6) | |||
| Cash Flow from Operations | 43.2 | 150.0 | 189.0 | 66.4 | 514.7 | 686.1 |
| Capex | (49.0) | (7.4) | (6.5) | (10.1) | (39.1) | (15.1) |
| Free Cash Flow | (5.8) | 142.6 | 182.5 | 56.3 | 475.6 | 671.0 |
| Dividends | 0 | 0 | 0 | |||
| Discretionary Free Cash Flow | (5.8) | 142.6 | 182.5 | |||
| Balance Sheet | ||||||
| Cash & Equivalents | 49.8 | 351.4 | 137.9 | |||
| Short term Investments | 0 | 0 | 0 | |||
| LT Debt | 60.7 | 32.1 | 318.3 | |||
| ST Debt | 4.3 | 12.9 | 9.3 | |||
| Total Debt | 65.0 | 45.0 | 327.6 | |||
| Net Debt | 15.2 | (306.4) | 189.7 | 261.2 | (79.7) | (589.0) |
| Credit Ratios | ||||||
| Net Debt/EBITDA | 0.1 x | -1.6 x | 0.8 x | 0.7 x | -0.1 x | -0.8 x |
| Total Debt/EBITDA | 0.6 x | 0.2 x | 1.4 x | |||
| EBITDA/Cash Interest | 57.9 x | 41.4 x | 18.1 x | |||
Source: Bloomberg
