TEXT - S&P cuts Cash Store Financial Inc rating
Overview -- The Cash Store Financial Services Inc. reported weaker-than-expected earnings and slower-than-expected growth during fiscal 2012. -- The company identified material weaknesses in internal controls during fiscal 2012, which resulted in restatements to the company's second- and third-quarter fiscal earnings. -- As a result, we are lowering our issuer credit and senior secured notes issue ratings to 'B-' from 'B'. -- Our negative outlook is based on uncertainty with respect to CSF's governance and accounting related to the acquisition of loan receivables in January 2012. Rating Action On Jan. 10, 2013, Standard & Poor's Ratings Services lowered its long-term issuer credit rating on Edmonton, Alberta-based The Cash Store Financial Services Inc. (CSF) to 'B-' from 'B'. We also lowered our ratings on CSF's senior secured notes to 'B-' from 'B'. The '4' recovery rating on the senior secured notes, indicating average (30%-50%) recovery of principal if a default occurs, is unchanged. The outlook on the ratings is negative. Rationale The downgrade is based on the company's weaker-than-expected earnings, slower-than-expected growth, and recent governance and accounting issues related to the consumer loan portfolio that the company purchased from third parties during January 2012. Over the past year, CSF has been undergoing a number of transformations stemming from its business model shift from being a broker for payday loans to funding loans on balance sheet. During January 2012, the company raised debt and purchased third-party outstanding receivables that it previously brokered. By shifting its business model, management intends to capture payments that previously went to third-party lenders. Earnings, however, have been lower than we anticipated. In our view, based on CSF's growth strategy and expense rationalization measures, the company may have difficulty improving earnings in line with our original expectations. Furthermore, we expected the company to increase its presence in the Canadian and U.K. markets in 2012. Growth, however, was relatively flat during the year, and the company closed 63 branches in Canada, primarily during the third and fourth fiscal quarters. Although CSF retained some of its customers and realized its goal of reducing operating expenses, we do not expect earnings to reach the level that we previously projected. We also believe that provincial regulatory frameworks put in place over the last three years have had a more restrictive effect on earnings than we previously expected. Regulations involve pricing caps, minimum and maximum loan sizes, minimum and maximum loan terms, and rollover (extending a loan term for a fee) restrictions. CSF's operating margin during fiscal 2012 was $25.9 million, a 32% decline from fiscal 2011. The company identified material weaknesses in internal controls during fiscal 2012, which resulted in restatements to the company's second- and third-quarter fiscal earnings. The company noted that it did not maintain effective accounting processes and controls related to measurement of provisions for loan losses, premium paid to acquire the loan portfolio, intangible assets, and consumer loan receivables. For the second fiscal quarter ended March 31, 2012, management adjusted the fair value of its portfolio of acquired loans to $50 million from $80 million and recognized an expense of $36.8 million. Although these issues appear to be resolved without immediate impairment to the company's liquidity, CSF's tangible equity declined to negative $40.4 million as of fiscal year-end. We also believe that recent governance and accounting issues arising from the review of the loan portfolio purchase transaction could have implications for CSF's future operational and financial performance. Subsequent to year-end, the company noted that a special committee of the board was reviewing the receivables portfolio acquisition. We believe that this could distract the management team. Outlook Our negative outlook is based on uncertainty about CSF's governance and accounting related to the acquisition of loan receivables in January 2012. We could lower the rating if earnings decline because of expenses related to the review of the receivables acquisition transaction or if debt protection metrics deteriorate as a result of a combination of increased regulation and competition. We could revise the outlook to stable if governance and accounting issues abate while earnings, leverage, and interest coverage stabilize. Related Criteria And Research Rating Finance Companies, March 18, 2004 Ratings List Downgraded; Outlook Action To From The Cash Store Financial Services Inc. Issuer Credit Rating B-/Negative/-- B/Stable/-- Senior Secured B- B Recovery Rating 4 4
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