Reassuring update

Secure Trust Bank 18 January 2019 Update
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Secure Trust Bank

Reassuring update

Pre-close trading update

Banks

18 January 2019

Price

1,180p

Market cap

£218m

Net debt/cash (£m)

N/M

Shares in issue

18.5m

Free float

81%

Code

STB

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(4.8)

(19.5)

(33.6)

Rel (local)

(6.5)

(16.9)

(25.1)

52-week high/low

2,085.0p

1,162.5p

Business description

Secure Trust Bank is a well-established specialist bank addressing niche markets within consumer and commercial banking. It has launched a non-standard mortgage business. Former parent Arbuthnot Banking Group’s shareholding is now less than 20%.

Next events

FY18 results

28 March 2019

Analysts

Pedro Fonseca

+44 (0)20 3077 5700

Andrew Mitchell

+44 (0)20 3681 2500

Secure Trust Bank is a research client of Edison Investment Research Limited

Secure Trust Bank’s (STB’s) pre-close trading update was encouraging, indicating it expects to deliver results in line with management’s and the market’s expectations. The bank has proposed a stop on new mortgage origination, unhappy with current price pressure and loan to value metrics, but does not expect this to have a material impact on 2018 and 2019 numbers. The bank sees itself entering 2019 with positive business momentum and robust capital and is well placed to continue its selected growth strategy despite the current political uncertainty.

Year end

Operating income (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/17

129.5

27.0

116.4

79.0

10.1

6.7

12/18e

152.9

34.9

154.8

83.0

7.6

7.0

12/19e

174.0

44.4

191.7

90.0

6.2

7.6

12/20e

196.4

52.7

224.6

100.0

5.3

8.5

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Prudence pays

At a time when the market is wary of negative trading updates, we see STB’s statement as reassuring and the lending prudence well suited to the current environment. The bank feels vindicated in its earlier decision to reduce risk in the loan book. Profitability has been supported by this move through improved credit quality.

Outlook: Unchanged with mortgage hiatus

Having previously shown some concern over contracting mortgage-lending margins and rising loan to value metrics in the market, management has announced a proposed stop on writing new mortgage business until conditions improve, potentially when the regulatory environment becomes more level from 2020. This decision is not expected to affect 2018/19 earnings materially. Otherwise STB’s loan momentum remains strong: loans exceeded £2bn at the end of 2018 (versus £1.6bn 2017), similar to our forecast. The growth is driven by retail finance, motor finance (where it has migrated from sub-prime to near-prime, a larger target market) and SME lending (mostly invoice financing).

Valuation: Below book

STB’s shares are down 24.8% in the last three months and are now trading 9% below book value. This appears to discount a poor outcome with an ROE/COE model requiring an ROE of under 10% to match the current share price. We expect the bank to deliver an ROE of 11.1% in 2018, 14.0% this year and 15.6% in 2020. These are value-creating ROEs; as such, the bank is expected to trade at comfortably above its book value. Our DDM-based fair value of 2,443p suggests a P/BV of 1.8x. STB’s 2018e P/E of 7.6x does not look demanding given our EPS growth forecasts of 34% and 42% for 2019 and 2020.

Mortgage pause

STB’s decision to temporarily cease writing new mortgages might raise some eyebrows since this is an asset class that was one of the bank’s bases for earnings growth in the future. STB management has not ruled out mortgages as a key area for growth. It still believes in the growth opportunities in serving the 4.6 million people who are self-employed, contract workers or have complex income or recently restored credit histories. A restoration of more attractive margins and terms, perhaps when the regulatory playing field is levelled in 2020, may provide the opportunity for a resumption of new lending.

However, management had been previously flagging that they were concerned about the aggressive pricing in this mortgage market segment and the high loan to value metrics being applied by some lenders. Furthermore, the current economic and political uncertainty favours additional prudence. As a result, the bank was guiding to lower mortgage lending expectations ahead of the 2020 regulation changes and our estimate for mortgage loans accounted for just 5% of the loan book by 2020, and 2% of interest income before this announcement.

Forecasts unchanged

STB made clear in the update that trading remained strong and it expected to deliver 2018 results in line with management and market expectations. It also highlighted that the credit quality of new customer loans has been improving, with impairments in motor finance in particular falling significantly. The hiatus in new mortgage lending is not expected to have a material impact on our estimates which are unchanged at this stage. We still expect STB to retain its strong growth profile.

The ongoing political and economic question marks, particularly surrounding Brexit, mean there are heightened uncertainties over forecasts across the market. Nevertheless, STB’s repositioning of its loan portfolio has moderated the level of risk it would face in the evident of an adverse outcome for the UK economy.

We note the consensus GDP growth estimate for the UK in 2019 is 1.5%. Wage growth is expected to be subdued, but unemployment is forecast to remain low in the UK (at below 5%). If delivered, this would be good news for lenders such as STB. The latest Bank of England survey data shows that lenders are tightening criteria in consumer lending; this is conceivably a positive trend in our view. On the negative side, there was little evidence in the survey of any significant trend to wider lending margins. They seem to still be dropping in the household segment, but are at least stable for SME lending. In this context we note that although there has been much focus on tougher times in the retail sector, the higher promotional activity this generates can actually help STB’s retail finance business through the use of 0% or subsidised loans.

We are maintaining our loan growth forecasts of 28% and 15% for 2019 and 2020, respectively. De-risking and efficiency gains as the bank expands help drive our EPS growth estimates of 34% (2019) and 42% (2020). We expect the bank to deliver an ROE of 11.1% in 2018, then 14.0% and 15.6% in 2019 and 2020.

Valuation

Weaker financial markets affected by economic and political concerns have contributed to share price weakness of several of challenger/specialist banks’ shares. STB’s share price has fallen 25% in the past three months and 44% from its 12-month high: one of the weaker performances within our selected peer group (Exhibit 1). STB’s weaker than average share price is surprising given the rebalancing of the loan book it has undertaken.

Exhibit 1: Challenger/specialist lender share price performance

1 month

3 months

1 year

YTD

From 12m high

Secure Trust Bank

-13.6

-24.8

-34.4

-0.8

-44.3

1PM

9.8

-1.3

-11.7

12.0

-26.9

Close Brothers

5.7

-2.5

3.1

4.7

-10.4

CYBG

3.5

-34.4

-42.8

4.0

-48.7

Metrobank

-1.0

-30.8

-49.5

10.5

-53.9

OneSavings Bank

10.0

-1.9

-7.1

5.7

-18.5

Paragon

5.2

-10.3

-18.9

5.8

-26.9

PCF Group

-3.5

-9.0

36.5

-1.9

-19.3

S&U

1.2

-5.5

-8.7

0.7

-23.1

Average

3.9

-12.0

-12.4

5.2

-28.5

Source: Refinitiv, Edison Investment Research

The drop in the share price has de-rated the company’s shares and they are now trading below their book value at a price to book value of 0.9x. This is an eye-catching valuation given we expect the ROE in 2018 to be 11.1% (supported by STB’s update that it was on track to meet market expectations) and we forecast ROE to rise to 14.0% in 2019 and then 15.6% in 2020. These are value-creating returns and the shares should theoretically be trading at a significant premium to their book value, not below. Our unchanged DDM-based fair value of 2,443p per share implied 1.8x book value.

Turning to earnings multiples, the bank is trading on a 2018 P/E of 7.6x, below the peer-average of 12.7x, (8.7x if we exclude outlier Metrobank).

We think that as the market gains confidence that STB’s repositioning is indeed working, this will be reflected in its rating. On this basis, the trading update is clearly a positive indicator.

Exhibit 2: Challenger/specialist lender comparative table

Price

Market
cap

2018
P/E

2019
P/E

2018
yield (%)

2017
ROE

Price to BV (x)

2017

Secure Trust Bank

1180

218.7

7.6

6.2

6.7

9.8

0.91

1PM

45.9

40.3

6.2

6.0

1.4

13.0

0.82

Close Brothers

1507

2287.5

10.9

10.7

4.2

16.3

1.70

CYBG

188.4

2700.3

7.2

7.3

1.6

10.6

0.52

Metrobank

1870

1827.6

40.5

21.5

0.0

1.7

1.47

OneSavings Bank

369.8

907.0

6.8

6.4

3.5

25.5

1.55

Paragon

408.2

1068.1

8.4

7.7

4.8

10.3

1.05

PCF Group

35.5

76.3

16.1

10.7

0.8

11.0

1.77

S&U

2145

258.5

5.2

4.6

4.9

16.7

1.66

Average

12.7

9.4

2.6

13.1

1.32

Source: Refinitiv, Edison Investment Research. Note: Priced at 15 January 2019.

Exhibit 3: Financial summary

Year-end December

2016

2017

2018e

2019e

2020e

£m except where stated

Profit and loss

Net interest income

92.5

114.6

134.0

150.3

170.8

Net commission income

14.5

14.9

18.9

23.8

25.6

Total operating income

107.0

129.5

152.9

174.0

196.4

Total G&A expenses (exc non-recurring items below)

(64.3)

(71.3)

(86.0)

(95.0)

(105.8)

Operating profit pre impairments & exceptionals

42.7

58.2

66.9

79.0

90.5

Impairment charges on loans

(23.3)

(33.5)

(34.0)

(35.9)

(37.9)

Other income

0.0

0.3

0.0

0.0

0.0

Operating profit post impairments

19.4

25.0

32.9

43.1

52.7

Non-recurring items

0.0

0.0

0.0

0.0

0.0

Pre tax profit - continuing basis

19.4

25.0

32.9

43.1

52.7

CorporationTax

(5.2)

(5.1)

(5.6)

(7.3)

(9.0)

Tax rate

26.8%

20.4%

16.9%

17.0%

17.0%

Bank tax surcharge

0.0

0.0

(0.4)

(1.5)

(2.2)

Profit after tax - continuing basis

14.2

19.9

26.9

34.3

41.5

Discontinued business

123.3

3.9

0.0

0.0

0.0

(Loss)/profit for year

137.5

23.8

26.9

34.3

41.5

Minority interests

0.0

0.0

0.0

0.0

0.0

Net income attributable to equity shareholders

137.5

23.8

26.9

34.3

41.5

Company reported pre-tax earnings adjustments

7.9

2.0

2.0

1.3

0.0

Reported underlying pre-tax earnings (ex discontinued 2015/16)

27.3

27.0

34.9

44.4

52.7

Reported underlying earnings after tax

20.6

21.5

28.6

35.4

41.5

Average basic number of shares in issue (m)

18.5

18.5

18.5

18.5

18.5

Average diluted number of shares in issue (m)

18.6

18.6

18.6

18.6

18.6

Reported diluted EPS (p)

77.3

107.0

144.9

184.7

223.2

Underlying diluted EPS (p)

113.0

116.4

154.8

191.7

224.6

Ordinary DPS (p)

75.0

79.0

83.0

90.0

100.0

Special DPS (p)

165.0

0.0

0.0

0.0

0.0

Net interest/average loans

8.15%

7.72%

7.34%

6.44%

6.06%

Impairments/average loans

2.04%

2.30%

1.87%

1.54%

1.34%

Cost income ratio

60.1%

55.1%

56.2%

54.6%

53.9%

Balance sheet

1.28

Net customer loans

1,321.0

1,598.3

2,050.0

2,620.0

3,015.0

Other assets

189.0

293.3

306.3

391.5

450.5

Total assets

1,510.0

1,891.6

2,356.3

3,011.5

3,465.5

Total customer deposits

1,151.8

1,483.2

1,971.2

2,543.7

2,927.2

Other liabilities

122.2

159.3

149.4

213.3

259.9

Total liabilities

1,274.0

1,642.5

2,120.6

2,757.0

3,187.0

Net assets

236.0

249.1

235.7

254.5

278.5

Minorities

0.0

0.0

0.0

0.0

0.0

Shareholders' equity

236.0

249.1

235.7

254.5

278.5

Reconciliation of movement in equity

Opening shareholders' equity

141.2

236.0

249.1

235.7

254.5

Profit in period

137.5

23.8

26.9

34.3

41.5

Other comprehensive income

(1.8)

2.9

(25.8)

0.0

0.0

Ordinary dividends

(13.1)

(14.0)

(14.8)

(15.5)

(17.6)

Special dividend

(30.0)

0.0

0.0

0.0

0.0

Share based payments

0.2

0.4

0.3

0.0

0.0

Issue of shares

2.0

0.0

0.0

0.0

0.0

Share issuance costs

0.0

0.0

0.0

0.0

0.0

Closing shareholders' equity

236.0

249.1

235.7

254.5

278.5

Other selected data and ratios

Period end shares in issue (m)

18.5

18.5

18.5

18.5

18.5

NAV per share (p)

1,277

1,348

1,276

1,378

1,507

Tangible NAV per share (p)

1,229

1,292

1,213

1,315

1,445

Return on average equity

72.9%

9.8%

11.1%

14.0%

15.6%

Normalised return on average equity

9.9%

8.9%

12.2%

15.1%

17.1%

Return on average TNAV

10.3%

9.3%

12.9%

15.9%

18.0%

Average loans

1,134.6

1,484.6

1,831.6

2,335.0

2,817.5

Average deposits

1,067.5

1,321.7

1,686.3

2,262.2

2,735.4

Loans/deposits

114.7%

107.8%

104.0%

103.0%

103.0%

Risk exposure

1,264.0

1,446.1

1,818.4

2,291.7

2,583.8

Common equity tier 1 ratio

18.0%

16.5%

13.2%

11.2%

10.7%

Source: STB data and Edison Investment Research forecasts

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This report has been commissioned by Secure Trust Bank and prepared and issued by Edison, in consideration of a fee payable by Secure Trust Bank. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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General disclaimer and copyright

This report has been commissioned by Secure Trust Bank and prepared and issued by Edison, in consideration of a fee payable by Secure Trust Bank. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the Edison analyst at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

Neither this document and associated email (together, the "Communication") constitutes or form part of any offer for sale or subscription of, or solicitation of any offer to buy or subscribe for, any securities, nor shall it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. Any decision to purchase shares in the Company in the proposed placing should be made solely on the basis of the information to be contained in the admission document to be published in connection therewith.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document (nor will such persons be able to purchase shares in the placing).

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a) (11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

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Germany

London +44 (0)20 3077 5700

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United Kingdom

New York +1 646 653 7026

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US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

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NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

295 Madison Avenue, 18th Floor

10017, New York

US

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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