Stock markets worldwide continue to be buffeted by shifts in investor sentiment and the reaction to political developments such as President Bill Clinton's videotape and the impending German elections. Closer to home, and in the middle of all of this market volatility, the flotation of one of Ireland's largest former building societies - First Active - is about to take place.
First Active is one of the market leaders in the Irish mortgage market, with a market share of 13.5 per cent. First Active also has operations in Northern Ireland and more recently it has expanded into Britain. To many, it will be viewed as a somewhat smaller version of Irish Permanent. While there are significant differences between the two companies, the fact that the core market of both is the Irish mortgage market means that investors will view them as close proxies of one another. The main difference between the two institutions is that Irish Permanent is much further down the road of being a full-service bank.
On a long-term view First Active does seem to offer an attractive investment given that its core mortgage market seems set to continue to grow strongly in coming years. Growth in the mortgage market in 1998 is forecast at around 18 per cent and the impact of lower mortgage rates next year, due to monetary union, should ensure another year of strong growth. Medium-term growth in the demand for mortgages is underpinned by the Republic's young population and rising employment levels.
Financial institutions have generally viewed mortgage lending as very low risk and in the Republic this is certainly borne out by experience. In contrast, the British market witnessed major problems in the late 1980s and early 1990s as house prices collapsed. In part, the problems in the British market were caused by a loosening of lending criteria, where many purchasers could borrow 100 per cent of the purchase cost.
In the Republic, lending criteria have remained fairly conservative with a typical maximum loan to value (LTV) ratio of 90 per cent. In practice many borrowers do not go to this maximum and recent data from the Department of the Environment point to an average LTV on new borrowing of 53 per cent. While a slowdown in the economy and the housing market would lead to some bad debts, the extent of any potential problem is likely to be modest.
One area where First Active does not score particularly well is in relation to costs. Its costincome ratio in 1997 was 60.6 per cent, compared with a ratio of 55 per cent for Irish Permanent. In the short term it will be difficult for First Active to reduce this ratio, particularly given the one-off costs of flotation which will be incurred this year. However, the experience of Irish Permanent suggests that over the medium term progress will be made in reducing costs relative to income.
The likely route to achieve this is through broadening the product range. As building society legislation has become progressively less prescriptive, First Active has been able to broaden its range of operations away from the core mortgage and savings areas into money transmission, non-mortgage borrowing and long-term savings. Non-mortgage lending has been extended and during 1998 a "flexible" car-loan product has been introduced.
First Active now sells a full range of insurance and investment products to its client base. It has a customer base of 250,000, and a key point of First Active's strategy will be to sell more investment products to this base. Non-interest income has increased from 9 per cent of total revenue in 1994 to just under 15 per cent in 1997 and is likely to grow steadily over the medium term.
As well as a broader product range in the Irish market, First Active has diversified into Britain. The key events in this expansion were: 1993, branch office opened in Northern Ireland; 1994, Mortgage Trust, a centralised mortgage lender, acquired for £22.2 million; 1996, The Mortgage Corporation acquired for £55.4 million; 1997, Northern Ireland operations of Cheltenham & Gloucester Building Society acquired.
First Active's pre-tax profits amounted to £31.7 million in 1997, representing a return on average assets of 0.72 per cent. The positive medium-term outlook for the Irish economy should underpin strong growth in earnings over the medium term. The flotation document includes a wide price range for the issue of new shares, reflecting current volatile market conditions. Given the strong medium-term fundamentals, an issue price close to the lower end of the price range is likely to prove attractive and those customers of First Active entitled to apply for new shares should avail of the offer assuming that the issue is priced conservatively.
