Australian Finance Group: AFG Securities remains the key attraction

About the author:

Author name:

By Azib Khan

Job title:

Senior Analyst

Date posted:

30 August 2021, 10:30 AM

Sectors Covered:

Banks

• Australian Finance Group (ASX:AFG) has reported FY21 statutory NPAT of $51.304m, which is 0.6% better than our expectation. A final dividend of 7.4cps fully franked has been declared. 
• We remain positive on the loan growth outlook for the AFG Securities (AFGS) business, which is AFG’s highest margin business segment.  
• Retain Add recommendation.

Non-bank lending business remains the key attraction

We have been pointing out our view that the growth outlook for the AFGS business is strong. AFG has said that AFGS lodgement volumes in 2H21 are up 80% on 2H20, supporting a strong settlement pipeline into FY22.

We are forecasting 104% growth in settlements for the AFGS business from FY21 to FY22F. 

RMBS pricing tailwind

We have also been pointing out that funding tailwinds are supporting the net interest margin (NIM) outlook. AFG has said that the current cost of funds outlook is expected to continue for at least the next six months.

We agree that RMBS spreads are likely to remain narrow for the remainder of this calendar year largely due to the banks having drawn down heavily on the Term Funding Facility in the leadup to the 30 June 2021 deadline as well as due to the banks continuing to experience strong growth in low-cost deposits.

For these reasons,  we expect  the  banks  to  remain  relatively inactive  in  term  wholesale funding markets, and we therefore expect investor demand to remain strong for non-bank  RMBS  paper  over  coming  months.

AFG’s  accounts  show  that  the weighted average effective interest rate for its securitised funding facilities was 1.43% in FY21, which we calculate equates to ~140bps over 1-month BBSW. We expect this cost to reduce to ~110bps over 1-month BBSW if current funding conditions are sustained. 

Warehousing funding cost tailwind

We believe marginal RMBS pricing is sitting notably below the cost of AFG’s warehouse funding facilities at the moment. For this reason, we see potential for further reduction in the cost of AFG’s warehouse facilities.

We understand these facilities are scheduled to be renewed later this calendar year, and we expect a reduction in the cost of these facilities to be negotiated  at  that  point  and  perhaps  earlier. 

AFG’s  accounts  show  that  the weighted average effective interest rate for its warehouse facilities was 1.83% in FY21, which we calculate equates to ~180bps over 1-month BBSW. We expect this cost to reduce to ~110bps over 1-month BBSW if current funding conditions are sustained. 

Asset mix tailwind

As we expected, the Link (near-prime) product accounted for a lower percentage of AFGS settlements in FY21 compared with FY20. However, we expect this percentage to increase in FY22 as the outlook for asset quality is not too concerning and funding conditions are conducive.

AFG has today said that it has “refreshed” its higher-margin near-prime product offering, which we take to mean that AFG will look to grow Link settlements in FY22F. AFG has also said that it will launch an SMSF product in 1Q22, which we presume will be a higher margin product than the Retro product. As a result of these factors, we expect a NIM tailwind for AFGS in FY22F from a favourable shift in asset mix. 

We continue to expect the front to back book pricing NIM headwind to be 20bps pa. 

We are forecasting the NIM to expand by 2bps from FY21 to FY22F. 

Acquisitive growth potential

AFG had unrestricted cash of ~$107m as at 30 June 2021. After allowing for working capital requirements, we estimate that AFG has surplus cash of ~$60m. While the Connective acquisition does not look to be going ahead at this stage, we expect AFG to explore other opportunities to acquire distribution. 

Acquiring distribution should result in even stronger growth in the AFGS loan book, which is an exciting potential prospect for AFG’s shareholders given that AFGS is comfortably AFG’s highest margin business segment.

Investment view and changes to forecasts

We have increased our normalised EPS forecasts by 2.5%/7.7% for FY22F/FY23F respectively. 

We retain an Add recommendation. Our target price, based on our DDM valuation, is (login to view target price).

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