Capital Support for Loans
Quote:
Originally Posted by
Snoopy
I am changing my analysis this year so that the financial statistics that I am evaluating are applied only to the financial division of the company.
I am applying a 'banking covenant' to a non-bank. While not a legal requirement for TNR, this is to enable a comparison with other listed entities in the finance sector (real banks like Heartland for instance ;-) ), so please bear with me. The data below may be found in the 'Consolidated Statement of Financial Position' (AR2016, p26).
Tier 1 capital > 20% of the loan book.
(Turners Group (Finance Division) has only Tier 1 capital for these calculation purposes.)
Tier 1 Capital = (Shareholder Equity) - (Intangibles: less Turners Auctions Intangibles) - (Deferred tax: Assume finance division using up deferred losses)
"Tier 1 capital > 20% of the loan book" is a Snoopy requirement
In the past on this forum, I have been absolutely pilloried for demanding a 20% capital buffer to be held to back up the loans of a second tier lending institution. This is primarily why I will invest in Turners, but won't invest in Heartland, that has a rather lower capital buffer.
Quote:
Originally Posted by
Snoopy
Car loans supported by bank loans require Turners to hold on the books, shareholders funds based on 20% of the value of the car loans, with the balance of the borrowed money charged out to Turners at a rate of 4.5 - 5.5%. Contrast that to the securitized loans.
Turners are only required to hold on the books 8% of the value of the securitized car loans (so they are more 'capital efficient'). Once a loan is securitized the BNZ (who does the securitization) gets direct access to the loan cashflows. As 'payment' for this privilege, the charge on securitized bank loan funding to Turners is reduced to 3.5 - 4.5%.
Yet as we found out at the first Turners road show, the Turners banks require a 20% capital buffer on the car loans they support, which is vindication that my own 20% back up capital 'requirement' was spot on.
This 'back up capital requirement' has been reduced to 8% when these same loans are securitized. I would suggest that the chance of a Turners Finance car loan 'going bad' does not change when that same loan is 'securitized' and bundled up with other similar loans to sell to the master financer - the BNZ bank. So the lesser capital requirement (down from 20% to 8%) is entirely due to the change in 'risk sharing' between 'Turners Automotive Group' and the BNZ who 'buy' the securitized loans. I put that word 'buy' in quotation marks. Yes the loans have been sold to the BNZ. But because Turners have retained a large proportion of the downside risk, they cannot be removed from the Turners balance sheet for accounting purposes. I imagine that Turners are fairly confident that their effective 'capital guarantee' will not be called upon. Otherwise the mere '1 percentage point saving in the interest bill points' to Turners would soon be swallowed up in capital losses.
I can see a curious conundrum in the Turners loan book. There is little doubt that to loan money on a second hand car implies a much greater potential 'capital downside loss' than if that same money was lent against a house (like Heartland's reverse mortgages) or even a cow (loans to share milkers - at least the cow can be butchered for 'cash recovery' even if the milk price collapses). Yet there is a very high incentive to keep up your car payments ahead of even a conventional mortgage. As Percy keeps reminding us, no car means no way to get to work, which means no way to keep up with any of your payments. Some here get excited with Turner's 'net interest margin' (NIM). But the higher NIM is needed, because the asset quality (car) underneath the loan will depreciate rapidly and is expensive to fix and on sell again if servicing is neglected. Thus the conundrum is car loans are on low quality assets, which means the interest rates on such loans are high. But the incentive to keep up paying for these loans is also high. So car loans are in a 'sweet spot' of the loan spectrum. The 'high interest' that customers pay to cover the 'high capital downside risk' looks to provide a higher reward/risk ratio than all other classes of loans.
SNOOPY