Specialty Finance Firm Valuation (FIG)

Hi All,

I am new to the forum but I have been following for a while. I am a new M&A analyst within the FIG sector and I was wondering what the forum thought about the valuation possibilities of specialty finance companies (Mortgage lenders, Asset Backed Securities, Credit Card Loans Etc).

I realize that they face regulation and if they are lending as a principal, they are likely to face Basel III regulations and therefore will be subject to targeted capital requirements which make it the same valuation methods as a bank (DDM, P/BV,PTBV) - however I guess I was wondering if the investors to the lender are corporate i.e Institutional Investors they would require a hurdle rate (cost of equity for the lender) but as an institutional investor - (Understand the risks) would the finance firm still be on the hook as a lender/banker and face Basell III? As these are not retail deposits.

I understand that if the firm is acting as a mere conduit, then they would be a service firm and “normal” valuation methods would apply. (DCF, EV/EBITDA) etc.

GL for level 2 CAIA results on Monday! I certainly think I failed …

Capital regulations depend on the business structure and not what they lend.

Hi RawRaw,

I understand this… The structure of the specialty lenders is similar to that of a bank except with a bank the money lent out is deposit holder cash and they make a spread on what they receive vs what they lend out.

Specialty lenders - lets say a credit card company - lend money out (as a business structure) with a balance sheet typically obtained from institutional investors. The risk of the card holder is then underwritten by the lender firm and rates return to investors in a typical bank spread.

So, I guess to summarize… Hedge funds and PE firms invest in certain investments subject to regulation, if they lose all the investors money, that is the risk the investor takes as they are considered “Sophisticated Investors”… With Specialty finance firms, the investors onto the balance sheet are also “Sophisticated lenders” to why would they be subject to capital regulation like a bank? They are not taking deposit holder (day-to-day people) money.

Different regulations apply to different activities. Some laws impact regulated depositories. Others cover the disclosures on the loans regardless who makes them. The federal reserve also regulates things other than banks (holding companies, tech providers, etc). It’s hard for me to talk in the abstract. Do you have a specific company in mind?

Hi RawRaw,

Optimum Credit (UK based company) for instance.

I don’t know much about non-US rules, but a quick Google search leads me to believe they are a mortgage company. In America,this company would likely not be subject to capital regulations, but would be subject to regulations regarding their lending activities (compliance disclosures and securitization rules like risk retention). They could be subject to Federal Reserve oversight if they were an affiliate or subsidiary of a holding company. They could be subject to FDIC/OCC/Federal Reserve oversight if they are a subsidiary of a bank. My understanding is that regulation in the UK is simpler than America, given we have state agencies and multiple federal agencies. Not sure if this helps

In terms of valuing a mortgage broker, it would just be like a typical model in my opinion. They tend to trade at low multiples given the volatility of the earnings stream relative to interest rates, which is very different from a bank which has a very consistent earnings stream when they don’t make bad loans.

Thanks RawRaw - I had the same feeling. Helpful response. Are you a FIG banker?

I worked in industry for a few years and then worked in research covering FIG for a few more years.

This is going be case by case. Mortgage lender for example, might also do equity release and put this into a ABS that an insurance firm can buy up. They can use this in their matching portfolio and now it’s solvency II. The specialist firm does not need to work under this framework

Bigger issue for valuation is where does the conduct risk sit now, most probably with the firm that transacted.