From Regulatory risk to investment opportunity?
MTC has been labeled as a growth stock since the IPO in late of 2014 due to aggressive branch expansion and promising loan growth in every year after unlocked funding problem. But in the recent period, MTC’s price declined for more than -25% to 32-34 baht/share from its peak at 44.25 baht/share in February 2018 despite of strong growth prospects from management team guidance that “In this year, MTC will have outstanding loan growth at 40% and every other aspect to grow at least 40%. MTC expected to expand branches to 2,800 branches in 2018 from approximately 2,400 branches in the last year” But why is that? I can break it into 2 factors that most of the market participants concern,
- Regulatory risk
- There is the lawsuit against MTC that the company overcharged interest and fees exceeds than 15% which imposed by The Civil and Commercial Code. The customers report this accusation to the Economic Crime Suppression Division (ECSD) in Thailand to investigate about it.
- Since there are many Thai micro finance companies such as MTC, Sawad, Nguen Tid Lor, Somwang, Local loan providers, loan shark and so on which are not rigidly regulated on many topics as such what is the maximum interest rate can be charged? How much fees are legally collected? and others. Therefore, the Fiscal Policy Office (FPO) was appointed to study on how to regulate company who is not supervised by BOT (Non-bank) and provides money to low-income customer without inappropriate charging interest rate and fee. Then, FPO is setting up the committee and drafting a new act of legislation to properly regulate Non-bank business.
- Market participants are afraid that this committee who has authority to impose maximum interest rate will lower total yield to 15% according to The Civil and Commercial Code has stated. If this scenario were about to happen, MTC will report breakeven profit or negative bottom line due to MTC’s yield including fee in 1q18 is 26.39% (24% of interest rate, 2.3% of fee income).
- Slower pace of growth
- The market become familiar with tremendous growth of MTC 73%, 86% and 50% of loan growth in 2015-2017, respectively. Meanwhile, in this year (2018) MTC expected to grow only 40% in loan portfolio which may trigger investor FAQ that Is the market saturated?
- We do not expect that the new act of legislation (issued within 2018) which supposed to supervise non-bank company, will lower interest rate charged to 15% where I don’t think any micro finance companies will survive with this rate even the most efficiency company like MTC. In addition, the regulators both Ministry of Finance and Bank of Thailand have no intention to sabotage the industry and expel customer inside regulated system to loan shark.
- Attractive valuation compares to growth in the future even the growth slowed down from 70-80% of loan growth after IPO but they can grow in range of 30-40% for at least 3 years from now according to management team.
- Robust asset quality with low NPL (overdue > 3 months) of 1.29% in 1q18 and high coverage ratio (Loan Loss Reserve) at 260%. MTC is aggressive on loan growth while remains conservative on credit control and set provision to cover losses. The company has been prepared for new accounting standard IFRS 9 for 2 years and according to management and advisor, they said the coverage ratio is sufficient in every scenario test.
(Source: Annual report 2018)
MuangThai Capital (Ticker: MTC) or previously called MuangThai Leasing (MTLS) has provided vehicle title loan to customers by using motorcycles, cars or agricultural vehicles as collateral via delivering the original registration book to the company’s custody without legally record and transfer the ownership in vehicle registration. In addition, MTC provides other loan products such as Personal loan (clean loan), Land title deed loan, Nano finance (Authorized by MoF) through the coverage of 2,638 (1q18) branches in all regions in Thailand. The branches are under supervision of regional managers who directly report to Branch Administration Department. Each branch will manage 10 sub branches and 10 service centers.
Vehicle Title Loan Business
- The Company provides vehicle title loan to individuals for all types and models of new and used automobiles including motorcycles, cars and agricultural trucks. The customer who applies for loan will have to deliver the original registration to the Company’s custody as collateral without any requirement to record the ownership transfer in that vehicle registration.
- MTC mostly focuses on Motorcycle title loan which account for roughly 40% of loan portfolio. Company is charging motorcycle title loan at 1.10% (flat rate per month) in 2q18.
Other loan Business
- Land title deed loan business – The Company provides service of land title deed loan, of which the customer will have to deliver the deed to the Company as collateral. The Company provides options for the customer whether to register the pledge at land office or not depending on the needed amount of loan and interest rate.
- Personal Loan – MTC received license to operate personal loan business from the Ministry of Finance (MoF) under supervision of Bank of Thailand in August 2006. Company provides unsecured loan only to the customers who has been MTC’s customer with good payment track record. Maximum effective interest rate can be charged at 28% per annum.
- Nano finance Business – Company has received permission from MoF to operate nano finance under BOT’s supervision in May 2015 with maximum effective interest rate at 36% per annum. Nano finance loan is unsecured loan that limit to 100,000 baht per contract and its objective is to funding SMEs and retail customers. Target group is the existing customers with good payment history.
- MTC has robust revenue growth and loan growth approximately 50% CAGR since 2011.
Loan receivable portfolio
New loan and avg. ticket size
- loan per contract is approximately 20,000 baht per contract and the maximum single loan contract is limited at 400,000 baht per contract which reduces the concentration risk to portfolio.
- 70% of new loan signed comes from existing customers and the rest 30% is from new customers.
Aggressive Branch expansion
- The management has previously set target to expand to 2,800 branches in 2018 but as I checked with Investor Relation, they said as of Jun-2018 they already have 2,888 branches and may have to revise target to 3,000 branches in this year. MTC expects to have 4,000 branches in 2020 for the long-term goal.
- As you can see on how they aggressively launched new branches every day or 500-700 branches each year in order to acquire foothold in any potential area to reach customer first. And the metric that we use to determine that Is the market saturated? Should the company slow down the branch expansion or not? by monitoring new loan per avg. branch and outstanding loan per avg. branch which we didn’t see any significantly and materially declined in efficiency ratio.
- Total yield (Interest rate + fees + other income) has slightly declined to steady level at nearly 26.4% in 1q18 from 29.5% in 4q14 while net interest margin maintains and gradually increased to 21.5% in 1q18 due to lower in cost of fund after IPO.
- MTC is the lowest interest rate charged to customers at effective rate 23-24% compares to major competitor charges customer with effective interest rate at 26-28%.
- Total industry competition becomes more intense and it forces players in the market to lower interest rate in order to maintain their market share. Please note that the customers will perceive the impact of different interest rate charged via each monthly payment including fees not by calculating of flat rate on the wall. Thus, people tends to go with the lowest interest rate stated in the first place but when they do realize that they pay higher than their friends they start to shift to a new one.
- On 8-Jun-2018, TRIS maintained rating of MTC at BBB (Stable) with positive in every aspects but there are 2 concerns on the intense competition in the market and the new regulation which will be set up new standard of interest rate charged that may hurt profitability in the future.
- Investor Relation (IR) said TRIS may revise their rating again after the clarity of new regulation in this year which may be a positive surprise if the new regulation is in our favor that would lead to lower cost of fund. Maybe BBB+ I guess.
- MTC has shifted the way they constructed source of fund by using more Long-term debenture up to 60% of total interest-bearing debt and reduced long-term loan and short-term loan from financial institution to proper level. The management stated that right now they try to lock up cost of funding by using more of long-term debt than short-term debt and they said cost of fund is likely to stable now.
- MTC has debt covenant with financial institution that they have to confine their DE ratio below 4 times. In my opinion, it’s not an obstacle to grow for 40% of loan portfolio in this year.
- MTC is gaining economies of scale due to 86% of total cost excluding bad debt expense was fixed cost in 2017 which comprised of 61% salary and employee benefit, 16% of Rental and services expense, 6% of Depreciation and amortization and 3% of Utility expense. Even though, the aggressive expansion in the last 2-3 years made significant increase in Human cost that grew from 514 mb in 2014 to 1,592 mb in 2017 but the company can efficiently manage the operating cost. There are just only 2-3 person in each branch.
- SG&A to total portfolio was sending down from 15% in 4q15 to around 10.3% in the latest quarter and cost to income ratio was declining as well from nearly 50% to 39% in 1q18 as a result of economies of scale benefit.
- Pre-provision operating profit to loan portfolio was gradually increased from 11% to 13.5% in 1q18.
- Loan receivable portfolio comprised of 78% of total portfolio is customers who are not yet due and 13% that past due not more than 30 days. MTC has no intention to collect fees as a major income from late paying-customer.
- MTC has strong asset quality with latest NPL (overdue > 3 months) at 1.29% in 1q18 and management team expected to control NPL within 1.5% of total portfolio in long term. As you can see, NPL was increasing from below 1% to 1.3% in latest quarter due to slower pace of growth and loan product mix changed through increasing in Land title deed loan and personal loan but at this rate is far below their competitor. MTC is slowing down their Land title loan product because they saw some increasing in delinquency rate that might be problematic.
- We are not worried on rising of NPL due to MTC has conservatively set provision not only for current accounting standard but also prepared for IFRS9 by setting General reserve from the possibility of default of each customer and take into account with the loss given default. MTC reported latest coverage ratio at 260% over NPL. (154% is policy reserve and 106% is general reserve)
Impact on new regulation
What if the new regulator imposes 15% of interest rate yield including fees upon micro finance companies like MTC, Sawad and others. What is the impact of it?
- In 2017, MTC has cost of fund at 2.35% (Finance cost divides by avg. loan portfolio), 10.4% of SG&A to total loan portfolio and Credit cost at 2.37% so the total cost to loan portfolio was 15.12% in 2017. Therefore, 15% of total yield (interest and fees income) will turn MTC’s bottom line into negative and the company might be forced out of the business.
The resolution toward this regulatory risk is that the company can break down loan for a customer into 2 contracts which comprises of a vehicle title loan contract with 15% of interest rate charged combines Nano finance contract with 36% of interest rate charged thus blended yield of combined contract will be approximately 24% – 28% depend on proportion of each contract.
And what is the appropriate rate should micro finance company charge consumer?
- Nobody knows but I think that new regulator will determine the appropriate rate by comparing with similar products such as personal loan (28%), nano finance (36%) and pico finance (36%) and the committee must consider that reducing interest rate charged to the point where there is no economic profit for the operators will likely to push low-income customer who has no credit to commercial bank back to loan shark or not?
Risk: Regulatory risk, Intense competition, Higher cost of funding, Deteriorating in Asset quality.