Standard & Poor's Ratings Services said today that it had assigned its 'B' long-term counterparty credit rating to 4finance Holding SARL, a nonbank consumer finance lender incorporated in Luxembourg. The outlook is stable.
Our rating on 4finance reflects the company's high exposure to regulatory and operational risks, short operating history, and concentrated business model. The company's strong earnings track record relative to peers', flexible and scalable business model, and strong quality of capital partly offset these weaknesses. The rating also incorporates our expectation that 4finance will continue to expand into new markets and show rapid balance-sheet growth.
4finance is a non-operating holding company. We base the rating on our view of the creditworthiness of the consolidated group, whose group credit profile (GCP) we assess at 'b'. We do not believe there are any material barriers to cash movement from the operating companies to 4finance. Therefore, the rating on the holding company is at the same level as the GCP.
4finance was founded in 2008 in Latvia as a nonbank consumer finance company that focused on granting short-term unsecured loans. All its lending is via the Internet, which enabled it to expand quickly into Lithuania, Finland, and Sweden by the end of 2010. 4finance now operates in 12 countries across Europe, and we expect its footprint will continue to expand. The company's small size and its short-term lending operations allow it to turn over its balance sheet many times each year and quickly increase its customer base. Although operating for just six years, by the end of first-quarter 2014, the company had 2.7 million registered customers, reviewed more than nine million loan applications, and granted 4.7 million loans.
The company relies on its substantial database of customer borrowing history, augmented by external resources to aid customer identification, credit scoring, and lending decisions. It offers single-payment and instalment loans with an average loan size of €325. The company focuses on customer service, with service teams speaking local languages in all 12 countries in which it operates, to mitigate credit risk through early and active debt collection. Its efforts at managing credit risk have resulted in loan losses that compare well with consumer finance peers', at roughly 5% to 8% of funds lent after two years.
4finance is exposed to significant operational and consumer-protection-related regulatory risks, in our view. The operational risks arise from the entirely online platform, which the company seeks to mitigate through regional support teams and backups to its information technology systems. It also relies on external debt collectors and legal proceedings for long-overdue loans.
The company is an early mover in many countries in which it operates, which gives it the ability to actively participate in the development of the regulatory framework. Still, it operates in countries with various approaches to regulating the nonbank consumer lending industry, and could face adverse regulatory developments that might hamper its operations. We expect that regulators will increasingly focus on rules that strengthen consumer finance protection. Regulation on marketing restrictions, interest rate caps, and borrowers' ability to repay could force the company to rethink its market strategy in light of potential profitability challenges in the future.
The company's revenue is fueled by lending at high interest rates, and its earnings are supported by low credit losses and a flexible cost base. Marketing is the largest expense, and impairment losses are rising but still small, so the company has been able to post very strong earnings compared with peers', which it has retained to support its rapid growth. 4finance's leverage is currently lower than peers', but we expect that it will increase as the balance sheet expands. Nevertheless, we also assume that the company will remain well capitalized, with a satisfactory base of tangible equity (unlike many peers that have negative tangible equity) to offset some of its business risks.
Currently, the firm's debt-to-EBITDA ratio is below 2x. We expect this to rise as its balance sheet expands, but that the ratio will likely also decline as the company retains earnings. Still, we do not believe the ratio will stay sustainably below 2.5x. We also forecast the company's EBITDA interest coverage ratio, currently higher than 4x, to decrease as interest costs rise alongside the expanding balance sheet. This ratio should also improve as earnings increase, but, in our view, the company's financial flexibility is relatively limited due to its private-ownership structure. We believe 4finance's owners would contribute capital as needed to support growth, but could demand dividends in the future.
The company takes little interest rate risk because it generally funds its operations using long-term debt and equity capital. It currently has $170 million of long-term debt, which matures in January 2015. We expect that 4finance's leverage will increase over time, but that the added lending capacity that comes with an expanding balance sheet will boost earnings and lower net funding costs. We also assume the company will retain the majority of those earnings.
The stable outlook reflects our expectation that 4finance will maintain its relatively strong capital and profitability while executing its growth plan. We also assume that the company will continue to enhance its corporate governance and internal control functions as it expands. Credit losses will likely increase as the loan portfolio expands, but not materially from current levels. We think future regulatory developments in several countries will likely constrain the company's ability to expand and increase profitability as rapidly as in the past, and lead to changes in the business model.
We could take a negative rating action if we saw material deterioration in asset quality, as indicated by portfolio loss rates rising consistently above 10% or the interest coverage ratio falling below 2x. We could also lower the rating if we saw regulatory changes that limit 4finance's ability to operate with its current business model across its markets.
We could raise the rating if we saw evidence that the company had successfully expanded its footprint while diversifying its product offerings, complying with regulations, and maintaining strong capital and earnings relative to peers'.