Shares magazine, Corporate Profiles.

Kensington prospers in a cooling market.

Just as the mortgage company lends where others fear to loosen their purse strings, so it feels comfortable while others feel a chill. Polly Ferguson reports.

Those who fear the property market will implode could be forgiven for thinking now might not be a good time to invest in a mortgage company. With the war in Iraq, weakening incomes and higher national insurance premiums hitting property owners, surely all sorts of people will be pushed into mortgage arrears - especially the 'reject' customers that mortgage company Kensington targets. It seems not.

Over the past few years, Kensington has done pretty well. For the full year to November 2002, it announced a 21% increase in pre-tax profits and a 48% increase in new business. A recent AGM statement confirmed that trading conditions have remained strong this year, with completions over the first quarter up 100% and the new business pipeline also over 100% up at 290 million.

All very well while the property market is on the up, but what happens when everything starts to fall?

CE John Maltby reckons poor conditions will in fact help Kensington. His reasoning is clear. Last year the UK housing market showed general house price increases of around 20%, helped by low interest rates. Now the top end of the market is softening, particularly in London. Kensington has limited exposure to these market hot-spots and instead focuses on areas such as Croydon and Wembley.

'Yes, the market place is slowing, but only in certain areas. About 11% of our properties are in inner London and only 5% of the loan book relates to the buy-to-let market. The property market is driven by global concerns, but it is counter-cyclical. Conversely, if there is a downturn, then more borrowers have problems, and that stimulates demand for our services', says Maltby.

Kensingon takes on the sort of business rejected by other mortage companies. It specialises in offering mortgages to 'non-conformers'. This means anyone who finds it tough getting a mortgage from traditional high-street lenders, such as those with a poor credit history, self-employed, retired or who are redundant.

Most of its properties are middle-market family homes valued between 70,000 and 250,000 and only around 6% of total properties are worth more than 250,000, so the company is relatively immune from any massive dives in house prices.

Kensington does not lend excessive amounts and has a lower loan-to-value (LTV) ratio than most of its competitors at 77%. While customers might be high risk, the level of defaults and repossessions is very small. An estimated 12% of clients are in arrears at any time, but this is offset by high margins at 3.8%. The number of new borrowers with county court judgments has reduced to less than 30% against 41% over the past year.

The company has 2.5 billion under management. This has climbed over the past year due to an improvement in distribution and the acquisition of The Mortgage Lender in 2002. 'The combination of initiatives aimed at broading distribution among intermediaries and the acquisition of TML will ensure strong upward momentum in new business this year', says analysts at Arbuthnot Securities, who rate Kensington one of their top 10 buy recommendations this month. Income from TML is driving up income and diversifying revenue streams away from relying on early redemption charges.

The company listed in 1999 and since listing, shares have been volatile. They started at 230p, went up to 282p in early 2002 and are now trading at 195p. Dividends were 8 times covered at 5p for 2002, compared with 2p the year before, and are forecast at 6p this year. EPS also climbed from 30.2p 39.8p in 2002.

Kensington has been dogged by weak sentiment, but it appears this mortgage company cannot be lumped together with other high-street lenderes. Its risk profile is a concern, but the company has shown it can manage the risks and make more money from customers. The shares are trading at just 4.2 times earnings, leaving the company plenty of room for upside. At 195p, investors should buy up toi 230p.

HSBC and Arbuthnot both say buy. SSSB says outperform.

I suspect Kensington's interims will be fairly positive when announced in the beginning of July. Except for London, the property downturn hasn't started to bite yet. Job losses in the City and reduced numbers of foreign buy-to-let investors are affecting the London market. But I not sure what is going to drive property down elsewhere.

A slow-down, yes. Going belly up, I'm not sure.

I suspect the market has already priced this in, as Kensington is on a prospective PE of 4.7