In an announcement to the stock exchange, the lender also unveiled its trading statement.
Key operational highlights
- Total new business completions for the Group (including Kensington Mortgages (KM), MPL, and Start) were over £1.5bn, which is in line with the same period in 2006, with the total offer pipeline up 4 per cent over the same period in 2006 to £607m. Kensington has retained its risk based pricing principles and not chased volume growth. The mortgage book was £7.1bn at the end of April 2007, compared to £7.2bn at the end of November 2006.
- Annualised net interest income as a percentage of average assets under management was 2.1 per cent in the period, compared to 2.6 per cent in the year ended November 2006. The Board expects that there will be continued pressure on the Group’s net interest margin as existing higher margin mortgages redeem and are replaced by the lower margin loans currently being written.
- Average Group gross reversionary margins on first charge new business in the period were 2.6 per cent down from 2.9 per cent in the same period last year. The level of interest received from borrowers in the initial lending period continues to be significantly reduced by the current high levels of “teaser” discounts prevalent in the UK market.
- The trend for more customers to wait until the end of the ERC period to repay their mortgage has continued and the lower income from ERC receipts is reflected in the reduction in net interest income margin above. Average ERC income received from ERC’s in the period was 2.73 per cent down from 3.46 per cent in the same period in 2006.
- Asset quality across the Group portfolio remains strong. The percentage of accounts 90 days or more in arrears at the end of April was 9.25 per cent, down from 10.46 per cent at the end of April 2006 despite the impact of a maturing portfolio and higher levels of whole loan sales. Crystallised loan losses in the five months were £13.6m, compared to £13.8m in the same period last year. The loan impairment charge for the period was £14.3m, compared to £22.9m in the same period last year. At 30 April 2007, the weighted average indexed loan-to-value ratio (LTV) of the UK portfolio remained low at 67 per cent (30 April 2006, 69 per cent) and 59 per cent of mortgage assets under management had a debt service ratio below 25 per cent.
- The new broader product range at KM has been well received by the market and KM’s new business pipeline was £457m at the end of April, an increase of 7 per cent over the same period last year. Approximately 26 per cent of the pipeline related to KM’s specialist prime first-charge mortgage range which is at lower margins than the core adverse business, and which is covered by the recently announced forward flow arrangement with Bradford & Bingley.
- MPL has had a challenging start to the year, with completions in the period down by 24 per cent compared to the prior period and the first charge pipeline at 30 April 2007 44 per cent lower than at the same time last year. MPL was loss making in the period. In May 2007, MPL entered into a forward flow arrangement with a third party to originate a broad range of products including a range of high adverse/high LTV mortgages, which are outside the Kensington Group’s risk criteria. Kensington is evaluating a possible impairment in the carrying value of the Group’s investment in MPL, which at 30 April 2007 was approximately £27m including debt.
- Start Mortgages, our mortgage business in Ireland, has once again performed strongly, generating attractive profits. The business continues to grow, with an increase in completions to 303m in the period compared to 208m in the same period last year, and margins remain strong.
- Bluestep, a specialist lender in Sweden in which the Group has a 15 per cent interest, performed in line wit management’s expectations.
- The sale of TML, Kensington’s direct to consumer mortgage business, was completed in April 2007. Aspreviously reported, an exceptional charge of approximately £8m will be recognised this year.
- During the period, £462m of mainly near prime business was sold through the established whole loan sale (WLS) programme. The average net return on WLS’s during the period was 1.16 per cent which was significantly lower than the 2.2 per cent average net return received in the first half of 2006, reflecting the change in value of the loans, and slightly below the average net return achieved in the second half of 2006 at 1.3 per cent. An additional £226m of specialist prime was sold in the period.
- In March, the UK business completed a securitisation issuance under the new KMS programme totalling£800 million which included collateral originated by KM and MPL. Demand among investors was strong, notwithstanding the issues affecting the US sub- prime market.
Kensington’s principal source of funding working capital has been to raise debt secured against the Group’s retained interests in its securitised mortgage book. This funding has been used to support writing new business, contribute to Group overheads and finance investments in new initiatives.
Historically, on completion of a securitisation, the Group was able to raise debt to cover all of the origination costs of the mortgages and the securitisation costs including a contribution of collateral to the securitisation vehicles. As the value of new business has reduced, the Group is no longer able to raise sufficient debt to cover all of these initial costs and therefore requires working capital to be found from other sources. As a result of this financing constraint, the Group has increased the proportion of whole loan sales, which generate cash on disposal. The Board expects that in the region of 60% of the Group’s lending in 2007 will be sold (approximately 25 per cent in 2006).
One consequence of the business review is that the Board has come to the view that, as an independent entity, the Group may not be able to raise sufficient capital in the debt markets to support significant growth in the size of the managed loan book.
As at 25 May 2007, Kensington had outstanding debt including bank loans of £256.8m (£334.6m on 30 November 2006) secured against the Group’s interests in its securitised mortgage book. The group also has a further £125m of subordinated debt which is due for repayment in 2015.
Business review
The business review announced on 23 March 2007 is seeking to address the challenges the business faces from increased competition, pressure on new business margins, lower ERC income and a cost base which is too high as a percentage of income. In addition, restrictions under the Group’s warehouse funding arrangements have limited the Group’s ability to develop new product lines. The business review, which is ongoing, has identified a number of immediate initiatives:
- A cost reduction programme targeting annualised savings in the region of £8m to be delivered by the end of two years, including the elimination of certain duplicated functions across the Group and the automation of certain business processes.
- A £9m capital investment in information technology to increase automation, enhance efficiency and improve competitiveness at the point of sale.
- Entry into a number of market segments where, subject to making appropriate funding arrangements, Kensington will be able to leverage its existing distribution platform and underwriting skills.
This estimate is before any potential impairment in the carrying value of Kensington’s investment in MPL and the approximately £8m exceptional charge in respect of TML.
Outlook
The Board is cautious about the short-term prospects for the Group and expects 2007 total revenue to be significantly below 2006.
The Boards of Kensington and Investec have reached agreement on the terms of a recommended offer for Kensington. Under the terms of the offer, each Kensington shareholder will receive 0.7 Investec shares plus a special dividend of 26 pence (payable by Kensington) for each Kensington share, valuing each Kensington share at 519.5 pence per share based on an Investec share price of 705 pence per share on 29 May 2007.
The Board is unanimously recommending this offer from Investec, a specialist banking group, which secures Kensington’s future as part of a stronger group with complementary capabilities at a fair price.
The Board believes that the combination of Investec’s stronger balance sheet, access to lower cost of funding, and capital markets expertise, together with Kensington’s recognised brand, established distribution, innovative product range, prudent risk management and track record for service excellence, create a strong combination for the growing non-standard mortgage marketplace.
As the consideration for Kensington is primarily in the form of shares, Kensington’s shareholders will have an opportunity to share in value created from the combination, and will also benefit from Investec’s broader franchise across a range of markets and geographies.
