Secure Trust Bank — Solid FY20, ready for growth

Secure Trust Bank (LSE: STB)

Last close As at 18/03/2024

GBP6.80

−12.00 (−1.73%)

Market capitalisation

GBP132m

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Research: Financials

Secure Trust Bank — Solid FY20, ready for growth

Secure Trust Bank (STB) reported FY20 PBT of £20.1m versus our estimate of £13m. The beat was mostly driven by lower than expected impairments (2.3% vs 2.7%). PBT was about 50% down on FY19, but the ROE of 6.2% shows resilience given the pandemic. STB’s Q3 update and pre-close statement had already indicated that asset quality was better than expected and business volumes were holding up relatively well. The latest lockdown is affecting H121, but we estimate loan growth of 5% and 15% for FY21 and FY22. We see impairment dropping to 1.5% by 2022, which should help drive ROE to 11.1%. The share price has rebounded but STB still trades on an FY21 P/BV of 0.79x, despite a strong track record of value creating returns (ROE above COE). Its solid good capital base (CET1 14.2) supports management’s strategy of seeking growth opportunities both organically and through possible M&A. We have increased our fair value to 2,163p/share (from 1,756p) mainly due to rolling forward one year.

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Financials

Secure Trust Bank

Solid FY20, ready for growth

FY20 results and outlook

Banks

9 April 2021

Price

1,212p

Market cap

£225m

Net debt/cash (£m)

N/M

Shares in issue

18.6m

Free float

84.5%

Code

STB

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

16.5

31.9

25.0

Rel (local)

12.4

29.2

(0.9)

52-week high/low

1,210p

562p

Business description

Secure Trust Bank is a well-established specialist bank addressing niche markets within consumer and commercial banking. It is launching a non-standard mortgage business. Former parent Arbuthnot Banking Group’s shareholding is now less than 10%.

Next events

Q1 trading update

June 2021

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 (STB) reported FY20 PBT of £20.1m versus our estimate of £13m. The beat was mostly driven by lower than expected impairments (2.3% vs 2.7%). PBT was about 50% down on FY19, but the ROE of 6.2% shows resilience given the pandemic. STB’s Q3 update and pre-close statement had already indicated that asset quality was better than expected and business volumes were holding up relatively well. The latest lockdown is affecting H121, but we estimate loan growth of 5% and 15% for FY21 and FY22. We see impairment dropping to 1.5% by 2022, which should help drive ROE to 11.1%. The share price has rebounded but STB still trades on an FY21 P/BV of 0.79x, despite a strong track record of value creating returns (ROE above COE). Its solid good capital base (CET1 14.2) supports management’s strategy of seeking growth opportunities both organically and through possible M&A. We have increased our fair value to 2,163p/share (from 1,756p) mainly due to rolling forward one year.

Year end

Operating income (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/19

165.5

38.7

180.2

87.2

6.7

7.2

12/20

166.1

20.1

85.2

44.0

14.2

3.6

12/21e

165.7

27.4

115.2

46.1

10.5

3.8

12/22e

190.8

41.5

175.0

70.0

6.9

5.8

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

FY20: Resilient 6.2% ROE; surprise 44p dividend

Along with better than expected impairments, it was reassuring to see loan payment holidays dropping significantly. Loan balances did fall 4% y-o-y, with the biggest impact in motor finance, but this was expected. Interest margins held up (6.2% NIM) while good cost control resulted in a cost to income ratio of 55%, an improvement on FY19 (57%). Management announced a surprise dividend of 44p (c 50% pay-out), a clear reflection of its confidence in the business outlook.

Impairments and growth key drivers

There is naturally some uncertainty regarding job furlough schemes and other support measures, but we expect the government to take a pragmatic approach to tapering them off. As such we do not envisage a cliff-edge scenario despite the clear risk to forecasts. We believe that STB’s relatively short duration book and proven nimbleness helps it adjust to lending conditions. We estimate STB’s impairments will drop from 2.3% of loans in FY20 to 1.5% by 2022 and this along with balance sheet expansion will help drive earnings growth.

Valuation: Fair value of 2,163p per share

We obtain a fair value (FV) of 2,163 per share using a net asset value (NAV) approach. We continue to assume a sustainable ROE of 13.5%, 10% in COE and 2% annual growth. FV is the present value (PV) of the (ROE-g)/(COE-g) formula at end 2022 discounted to FY21. The 2,163p value implies an FY21e P/BV of 1.4x; STB is currently trading on a 0.79x P/BV ratio.

Investment summary

FY20 results better than forecast

STB is a specialist bank with a strong growth profile that had been shifting into a lower-risk lending mix ahead of the pandemic. This was being driven by market conditions and Brexit concerns. The bank was quick to adjust to new lending conditions due to the pandemic while the UK government and central bank provided important support measures. As a result, impairments came in lower in FY20 than expected as did loan payment holidays. Loan volumes did decline (especially in motor finance, which was more affected by the lockdown) but recovery in some segments (such as commercial finance) before the end of the year led loans to be down only 4% y-o-y on FY19. Interest margins held up while cost cutting led the cost to income ratio to drop 57% to 55%. As a result, while FY20 PBT was down almost 50% on FY19, it still ahead of our forecasts by more than 50% and the reported ROE of 6.2% showed good business resilience.

Now ready for growth with no cliff-edge

The latest lockdown is impacting business this year. However, the successful vaccine roll-out leads to expectations of a likely return to more normal trading conditions this year, particularly in the second half. We expect UK government and central bank to continue to be pragmatic in their support measures and we do not envisage an economic cliff-edge scenario where this support is removed excessively quickly or in a disorderly fashion. We expect that STB’s loan growth will be relatively modest in FY21 (forecast 4%). We forecast that a decline in impairments (from 2.3% to 1.6%) will help drive ROE to 7.8% in FY21. We introduce FY22 forecasts, and we expect loan growth to increase to 15%, interest margins to remain stable and a ROE of 11.1%. STB’s Common Equity Tier 1 (CET1) is 14.2% which allows STB room to expand its balance sheet. The bank plans to explore possible value-accretive M&A opportunities in addition to organic growth. In its disclosed mid-term objectives, management has included a ROE of 14–16% with a CET1 of more than 12%.

Valuation: 2,163p per share

We have increased the FV from 1,756p per share to 2,163p after rolling forward one year. We discount the PV at the end of FY22 based on the (ROE-g)/(COE-g) formula back to FY21. All other assumptions remain the same: sustainable ROE of 13.5%, 10% in COE and 2% annual growth.

Risk factors

Macro cycle– the economic recovery may end up being slower than expected.

Optimistic provisioning – there might be excessive optimism in the bank’s internal loan loss model assumptions.

M&A – acquisitions bring execution risks and, especially in the finance world, balance sheet surprises. However, they can also have a positive transformational impact adding scale and the opportunity to improve a previously non-core activity.

FY20 better than expected

STB reported PBT of £20.1m well ahead of our forecast of £13m. Earnings were about half of what was achieved in 2019; but the fact that STB managed to deliver a return on equity (ROE) of 6.2% with the challenges of such an unusual year is quite salutary. The key positive surprise was the lower than expected loan impairments, which are in part due to the government support measures including the job furlough scheme.

The reported earnings, strengthened capital base, proven business model and management’s confidence in the outlook led management to declare a surprise dividend of 44p per share.

Operating income held up

Net interest income grew 4% y-o-y in 2020, similar to our forecast of 5%. Net interest margins remained sturdy at 6.3%. Interest margins received some support from lower interest rates on the funding side, but STB also protected its margins on the lending side.

Fee income inevitably suffered from lower new business volumes. Net fees (and commission income) declined by 24%; however, they were actually 8% above our forecasts. Total operating income held up during the crisis and was flat at £166.1m and was similar to our forecast of £167m.

Operating costs fell 3% as a result of cost cutting and some investment reduction and this allowed pre-provision profit to grow 4% y-o-y in a difficult year. The cost to income ratio was 55%.

Exhibit 1: FY20 results vs FY19 and FY20 forecasts

£m unless stated  

Year end 31 December

FY19

FY20

Y-o-y %

FY20e

vs exp

Gross interest income

191.4

192.5

1%

196.7

-2%

Interest expense

(46.0)

(41.6)

-10%

(43.8)

-5%

Net interest income

145.4

150.9

4%

152.9

-1%

Net fees & commissions

20.1

15.2

-24%

14.1

8%

Total operating income

165.5

166.1

0%

167.0

-1%

Operating expenses

(94.2)

(91.6)

-3%

(90.7)

1%

Pre-provision profit

71.3

74.5

4%

76.3

-2%

Impairment charges on loans

(32.6)

(51.3)

57%

(56.8)

-10%

Losses on modification of financial assets

0.0

(3.1)

(6.6)

-53%

Earnings before tax

38.7

20.1

-48%

13.0

55%

Tax

(7.6)

(3.9)

-49%

(2.8)

41%

Tax rate

19.6%

19.4%

21.4%

Net attributable income

31.1

16.2

-48%

10.2

59%

Diluted EPS (p)

166.4

85.2

-49%

N/A

N/A

Diluted underlying EPS (p)

180.2

85.2

-53%

54.3

57%

Dividend per share (p)

83

44

-47%

0

Key ratios and balance sheet

Cost income ratio

57%

55%

54%

NIM (NII/average loans)

6.4%

6.3%

6.4%

Impairment charge % average loans

1.5%

2.1%

2.4%

Impairment charge (incl. loan modification losses) % avg loans

1.5%

2.3%

2.7%

Loan/deposit ratio

121.3%

118.4%

116.0%

CET 1 ratio

12.7%

14.2%

13.9%

ROE%

13.6%

6.2%

3.9%

Customer loans

2,450

2,359

-4%

2,325

1%

Customer deposits

2,020

1,993

-1%

2,010

-1%

Source: Secure Trust Bank, Edison Investment Research

Better than expected impairments drove earnings beat

Total loan impairments were 2.1% of average loans, or 2.3% adding the losses on loan modification due to payment holidays. We were forecasting 2.4% and 2.7%, respectively.

The good impairments performance was helped by STB having already a relatively cautious lending stance coming into the pandemic and then it reacted quickly as the outlook deteriorated because of the pandemic. In addition to this, the UK government’s support measures, notably the extension of the employment furlough system in the second half of 2020, were supportive. The good asset quality trends were already flagged by the bank’s management in its trading update in October and the pre-close statement. The motor and retail finance loan payment holidays came down sharply from their peaks in May 2020. Retail finance holidays peaked at over 2% of loans and were only 0.5% at the end of 2020. Motor finance payment holidays reached almost 15% and dropped to only 1.2%.

Exhibit 2: Gross lending yield and LLC* rate (%)

Exhibit 3: Gross lending yield net of LLC rate (%)

Source: Secure Trust Bank, Edison Investment Research. Note: *LLC: loan loss charge.

Source: Secure Trust Bank, Edison Investment Research

Exhibit 2: Gross lending yield and LLC* rate (%)

Source: Secure Trust Bank, Edison Investment Research. Note: *LLC: loan loss charge.

Exhibit 3: Gross lending yield net of LLC rate (%)

Source: Secure Trust Bank, Edison Investment Research

Loan balances fell 4%

Although there was a 4% decline in total loan balances in 2020, we note that the loan book was flat in the second half of 2020 if we exclude the two non-core books (asset finance and retail mortgages, which combined represent 3% of loans) being run down.

Real estate loans grew 9% y-o-y in FY20 driven by existing deals, but the pace of growth slowed down in the second half of the year with STB’s increased caution. The trend was different in some of the other books. Commercial finance was initially hit very hard by the lockdown and loans fell 24% in the first half of 2020. Commercial finance lending (essentially invoice discounting) then rose 20% in the second half of the year as business picked up with the end of the first lockdown and also adjusted to new trading conditions. Commercial finance loan balances nevertheless dropped 8% y-o-y in FY20.

Consumer loans fell 12% y-o-y in 2020, with motor finance (-25% y-o-y) particularly hard hit by the lockdowns, which have closed car dealerships. Lending in retail finance fell 4% y-o-y, with lending volume recovering in the second half of the year. These lending trends had already been highlighted in previous statements and we believe were expected by the market.

The loan book profile at the end of FY20 is shown below. Commercial real estate (70% for investment and 30% development) is now almost half of the loan book, while retail (V12, point of sale) lending represents 28% of the loan book.

Exhibit 4: Loan breakdown FY20

Source: Secure Trust Bank, Edison Investment Research

Robust capital position: CET 1 of 14.2%

STB’s CET1 ratio rose from 12.7% in FY19 to 14.2% in FY20. We had forecast 13.9%, the difference being mostly the higher than forecast earnings. Retained earnings and the balance sheet reduction drove this increase. The Bank of England’s IFRS 9 transitional capital relief measures provided a 20bp boost to CET1 in 2020. As it currently stands, we see the CET1 as not only comfortable but also allowing STB to be in a position to resume significant balance sheet expansion as well as explore M&A opportunities. Balance sheet liquidity remains good and the loan to deposit ratio was 118% at the end of FY20.

Outlook

The successful vaccine rollout and the roll back of lockdown conditions provides a strong light at the end of the tunnel. Risks still exist to this progression, for example new variants may alter the outlook. There is also the uncertainty regarding the impact on the economy and banks as central bank and government support measures (such as the job furlough scheme) come to an end.

No cliff edge

Our view is that there will be no cliff-edge scenario where an unfavourable economic shock is created by a hurried and early end to these support measures. We believe that lessons have been learnt from the previous economic crisis of 2007–8. The UK government and the central bank have been very pragmatic in their support and we see no reason why this will not continue. We think great care will be used in the tapering of support.

Having said this, it is inevitable that there will be an increase in the unemployment rate and this is a key factor for nonperforming loan (NPL) formation for banks and for STB. Exhibit 5 shows the latest collected consensus forecasts: a 1.1% percentage point increase is forecast in UK unemployment at the end of 2021 (to 6.2%). This does not seem extraordinarily difficult for STB to manage and we note that earlier forecasts in mid-2020 suggested that unemployment would already exceed 8% by the end of 2020. The company’s internal scenarios forecasts are discussed and shown in the ‘Impairment internal scenarios’ section on page 7.

Exhibit 5: UK economic forecasts

2018

2019

2020

2021e

2022e

GDP

1.3

1.5

(9.9)

5.9

3.2

GDP*

1.3

1.5

(9.9)

4.8

6.1

Private consumption*

1.6

1.0

(9.6)

5.0

4.5

Unemployment*

4.1

3.8

5.1

6.2

5.4

Budget deficit % GDP

(2.2)

(2.1)

(16.5)

(9.2)

(7.1)

Gross debt % GDP

85.7

85.4

108.0

111.5

113.4

Source: ONS historical data, IMF forecasts. Note: *Bank of England average independent forecasts March 2021.

The lockdown in H121 is affecting lending, especially in the consumer lending segment. We expect loan growth will be stronger in the second half, particularly in motor lending. STB management is still not issuing guidance due to the uncertainty in the shape of the economic recovery. However, it obtains confidence from the proven resilience of its diversified business model and the strong balance sheet.

We expect STB to be able to return to growth once lending conditions improve and the economic outlook becomes clearer.

Two-prong growth strategy

The message when David McCreadie was appointed as STB’s new CEO in January 2021 was of a seamless transition and that the core growth strategy of organic expansion and M&A opportunities was expected to remain the same.

As the economy emerging from this crisis, management sees the bank as well positioned to explore and capitalise on opportunities. The bank has operational scalability in its lending segments, comfortable capital ratios and expected good profitability to help fund growth. At the same time (and despite the surprise dividend payment announcement) the pay-out ratios may need to be revised downward to support identifiable growth opportunities We believe that this may lead to pay-out ratios perhaps not being as high as the c 50% in the past if management does not believe it is in the best interests of the bank.

STB management has disclosed several medium-term performance targets for the group: (1) a net interest margin of 6.0% (FY20: 6.3%), (2) a cost to income ratio of 50–55% (FY20: 55.1%), (3) an ROE of 14–16% (FY20: 6.1%) and (4) CET 1 ratio of more than 12.0% (FY20: 14.2%).

These targets seem to us appropriately ambitious and at the same time achievable and consistent with STB’s business model. If achieved, this means attaining a value-creating ROE well above the cost of equity (COE) (we use 10% as the benchmark), while maintaining a solid capital base. And as we discuss later in the valuation section, this would result in considerable upside potential in the share price, which is currently only trading at a price to book value (P/BV) multiple of 0.79x. Exhibit 6 shows the historical ROEs with our two years of forecasts. STB’s returns have always been above 10% except for FY17 (8.9%) and this was only because the bank was still carrying significant undeployed capital after some asset sales. The CET1 ratio in FY16 and FY17 was 18.0% and 16.5%.

Exhibit 6: STB’s ROEs and CET1 ratios*

Source: Secure Trust Bank, Edison Investment Research. *Note: we show data labels for ROEs only

Exhibit 7: Management’s outlook commentary, by segment

Segment

Outlook comments in management’s annual report

Business finance

Real estate

Immediate focus of the business remains on effective risk management and customer support. STB will manage appetite for new opportunities as the economic conditions become clearer going forward.

Commercial finance

The focus in 2021 will be on the continued protection of the balance sheet, in particular where clients are affected by the end of government backed assistance such as HMRC payment forbearance, furlough and business interruption payments. STB expects demand to return and is well-placed to take advantage of new business opportunities.

Consumer finance

Retail finance

Management expects a volume increase in the majority of retail sectors’ customer footfall as COVID-19 rules relax. STB’s online e-commerce service to retailers will continue to mitigate the impact of COVID-19 in many sectors, especially cycling, outdoor/leisure and electronics, as customers shop online.

STB will continue to invest to further enhance its system’s capabilities, to ensure that quality of service to both retailers and customers is maintained or improved as well as generating operational efficiencies. This includes the rollout of improved telephony systems across customer-facing staff and enhancements to the customer application process. This will provide a slicker customer journey by recognising returning customers of V12 Retail Finance in order to reduce customer time inputting their details.

Motor finance

STB will continue with restricted lending criteria to near-prime lending over the initial part of 2021, with those criteria being eased as the economic outlook becomes more certain. It remains committed to expanding into the prime credit market under the V12 Vehicle Finance brand, to drive long-term receivables growth and sustainable returns. The Motor Transformation Programme, which has seen £9.5m already invested since it started in 2018, will now focus on further system enhancement and delivery of a PCP product. Motor Finance is now well-placed to improve the credit quality of the portfolio, drive business growth and deliver stable earnings.

Debt management

In the short term, there is continued uncertainty brought by COVID-19, on both underlying collections levels and the rate of supply of new debt portfolios from UK financial institutions.

The longer-term outlook for the supply of debt portfolios remains positive as we expect that UK financial institutions will continue to sell and will do so at an earlier stage than historically.

Management will continue to invest in improving STB’s digital offering to customers to improve the customer experience and reduce its cost to collect.

Segment

Business finance

Real estate

Commercial finance

Consumer finance

Retail finance

Motor finance

Debt management

Outlook comments in management’s annual report

Immediate focus of the business remains on effective risk management and customer support. STB will manage appetite for new opportunities as the economic conditions become clearer going forward.

The focus in 2021 will be on the continued protection of the balance sheet, in particular where clients are affected by the end of government backed assistance such as HMRC payment forbearance, furlough and business interruption payments. STB expects demand to return and is well-placed to take advantage of new business opportunities.

Management expects a volume increase in the majority of retail sectors’ customer footfall as COVID-19 rules relax. STB’s online e-commerce service to retailers will continue to mitigate the impact of COVID-19 in many sectors, especially cycling, outdoor/leisure and electronics, as customers shop online.

STB will continue to invest to further enhance its system’s capabilities, to ensure that quality of service to both retailers and customers is maintained or improved as well as generating operational efficiencies. This includes the rollout of improved telephony systems across customer-facing staff and enhancements to the customer application process. This will provide a slicker customer journey by recognising returning customers of V12 Retail Finance in order to reduce customer time inputting their details.

STB will continue with restricted lending criteria to near-prime lending over the initial part of 2021, with those criteria being eased as the economic outlook becomes more certain. It remains committed to expanding into the prime credit market under the V12 Vehicle Finance brand, to drive long-term receivables growth and sustainable returns. The Motor Transformation Programme, which has seen £9.5m already invested since it started in 2018, will now focus on further system enhancement and delivery of a PCP product. Motor Finance is now well-placed to improve the credit quality of the portfolio, drive business growth and deliver stable earnings.

In the short term, there is continued uncertainty brought by COVID-19, on both underlying collections levels and the rate of supply of new debt portfolios from UK financial institutions.

The longer-term outlook for the supply of debt portfolios remains positive as we expect that UK financial institutions will continue to sell and will do so at an earlier stage than historically.

Management will continue to invest in improving STB’s digital offering to customers to improve the customer experience and reduce its cost to collect.

Source: Secure Trust Bank, Edison Investment Research

A core part of the strategy is to continue to focus on lending to high-yield niches where the cost of risk is appropriately remunerated. Management also aims to simplify the business and this involves continuing with running off the mortgage and asset finance books.

Management is also keen to increase the leveraging of its technological platform and investments. Technology is an important factor in client connection and service delivery in segments such as motor finance and retail finance as well as STB’s savings product. For example, the technology platform in the Motor Finance division allows STB to receive applications, make automated decisions, facilitate documents production through to the pay-out to motor dealers and also then manage in-life loan accounts.

The Exhibit 7 summarises STB’s outlook comments by business area as disclosed in the annual management report.

STB will organise a capital markets day in the second half of H221 where it will introduce leaders of the various business units, providing insight on the same and update on its progress and growth ambitions.

Loan forecasts: Lockdown affecting 2021

The continued lockdown in 2021 has been having an impact on STB’s business. We are making a downward revision to our loan balance forecasts for 2021 by 4% to £2,480m. This still represents a 5% increase from FY20. We expect most of this growth to come in the second half of the year after the lockdown ends and there is a return to something closer to normal in terms of business conditions.

We have also introduced estimates for 2022 with a forecast of a 15% increase in loans. We are assuming that consumer finance (motor and retail) and commercial finance will be growing in the mid-teens in 2022. After being more resilient during the pandemic, we are assuming that the commercial real estate finance will be growing at single digits. Exhibit 8 details our assumptions.

Exhibit 8: Loan book balance estimates

£m unless stated

2018

2019

2020

2021e

2022e

Real estate finance

770

962

1,052

1,100

1,210

Asset finance

63

28

10

0

0

Commercial finance

195

252

231

270

330

Business finance

1,027

1,242

1,293

1,370

1,540

Motor finance

276

324

244

270

350

Retail finance

597

689

658

680

820

Debt management

32

82

82

90

100

Retail mortgages

85

106

78

65

45

Consumer finance

990

1,201

1,062

1,105

1,315

Other

11

8

4

5

5

Total lending

2,029

2,450

2,359

2,480

2,860

Y-o-y %

Real estate finance

33

25

9

5

10

Commercial finance

54

29

-8

17

22

Motor finance

1

17

-25

11

30

Retail finance

32

15

-4

3

21

Total lending growth (y-o-y%)

27

21

-4

5

15

Source: Secure Trust Bank accounts, Edison Investment Research

Exhibit 9 shows our impairment assumptions. STB management expects impairments to decline significantly in 2021. We are assuming they decline from 2.1% (2.3% with loan modification losses) down to 1.6% in 2021 and then further down to 1.5% in 2022. When making the comparison with previous years, the motor finance lending business has moved from a sub-prime to near-prime segment.

We think there is risk to the impairment forecasts due to general macro risks and the aforementioned uncertainty of how unemployment in particular will react to the tapering of government support. The IFRS 9 impairment rules do encourage companies to front load their provisioning by looking at expected losses throughout the life of the loan as opposed to current conditions. But this does not mean that initial provisioning levels may end up being optimistic, especially if there are worse than expected macro developments.

STB does have the advantage of a relatively short duration in its lending book that allows the bank to more quickly adjust to lending conditions. This also means that problems tend to occur and be seen earlier rather than build up on the balance sheet and result in later, but larger adjustments.

Exhibit 9: Loan book impairment assumptions

% of average loans

2018

2019

2020

2021e

2022e

Real estate finance

(0.1)

(0.0)

(0.5)

(0.3)

(0.2)

Commercial finance

(0.0)

(0.0)

(0.5)

(0.2)

(0.1)

Motor loans

(4.1)

(4.6)

(7.3)

(5.0)

(4.0)

Retail finance

(3.7)

(3.1)

(2.2)

(3.0)

(3.4)

Total loans

(1.8)

(1.5)

(2.1)

(1.6)

(1.5)

Total loans incl. loan modification losses

(1.8)

(1.5)

(2.3)

(1.6)

(1.5)

(£m)

Impairments

(32.4)

(32.6)

(51.3)

(37.7)

(40.5)

Impairments + loan modifications

(32.4)

(32.6)

(54.4)

(37.7)

(40.5)

Source: Secure Trust Bank, Edison Investment Research

Impairment internal scenarios

STB discloses a range of forward-looking scenarios that it uses internally under IFRS 9 to help it set provisioning levels. The scenarios and their weightings help calculate the probability of default (PD) and the consequent expected credit loss (ECL). Exhibit 10 shows STB’s four scenarios with varying levels of unemployment and house price movements, which reflect different degrees of severity in the economic recession.

In our view, unemployment is the single most important factor in loan loss creation, and we draw some comfort from the fact that the peak unemployment assumptions that STB uses are higher than the 2021 year-end consensus expectations in all IFRS 9 scenarios except the ‘low’ scenario.

Exhibit 10: Internal company macro scenario assumptions for impairments under IFRS 9

Scenario

Scenario

weighting

UK unemployment rate (annual average)

UK HPI* – movement from Q420

2021e

2022e

2023e

5-yr avg

2021e

2022e

2023e

5-yr avg

Low

20%

5.9

5.9

5.2

5.1

(2.2)

(2.9)

1.9

3.7

Medium

45%

7.5

8.2

7.0

6.6

(4.1)

(7.4)

(2.8)

(0.3)

Hard

25%

7.7

8.4

7.2

6.7

(4.4)

(7.0)

(2.2)

0.0

Severe

10%

8.4

10.1

8.3

7.5

(16.4)

(24.4)

(20.4)

(16.3)

Source: Secure Trust Bank, *HPI: House Price Index from Land Registry (UK government)

STB estimates that if it had changed the weightings of the above scenarios to 100% severe case, it would have resulted in an additional £15.7m in impairments in FY20. This would involve heavier estimated impairments in Retail Finance, Motor Finance and Business Finance (as shown in Exhibit 11). On the other hand, a 100% weighting on the low-case scenario would have led to an £8.9m reduction in impairments. To put this into context, STB reported operating profit of £74.5m before impairments in FY20 and £54.5m in impairments (including the payment holiday-related value adjustments). Therefore, in its 100% weighted internal worst-case scenario, STB would have still reported a positive PBT (theoretically £4.4m, all other things being equal).

Assuming a 25% tax rate, the £15.7m of impairments would be only a 55bp hit to STB’s CET1 of 14.2%; this is an amount easily absorbed by the capital.

Exhibit 11: Additional provisions in extreme cases

Impairments (£ m)

Motor Finance

Retail Finance

Business Finance

Total additional impairments

Low-case 100% weighting

(3.0)

(3.8)

(2.1)

(8.9)

Severe-case 100% weighting

3.2

4.1

8.4

15.7

Source: Secure Trust Bank

Valuation

We continue to value STB on an NAV approach using the (ROE-g)/(COE-g) formula. The assumptions are the same: 13.5% sustainable ROE, 10% COE and a 2% increase in long-term earnings. We have assumed that this valuation is for end FY22 when the earnings will have started to normalise. We then discount this value back to end FY21 using the COE as the discounting factor. The FV has increased from 1,756p to 2,163p reflecting moving forward one year. This is equivalent of a P/BV of 1.42x compared to the current 0.79x, suggesting significant upside to fair value.

STB is still trading below its book value despite its track record of value-creating ROEs. And while we are forecasting an ROE below its COE (we use 10%) for FY21 at 7.8%, we estimate it to be above this at 11.1% already in FY22.

Exhibit 12: STB valuation (net asset value approach*)

ROE (%)

13.5%

COE (%)

10.0%

Long-term growth (%)

2.0%

Book value/share in FY21e (p)

1,525

Book value/share in FY22e (p)

1,655

Indicated fair value for FY22 per share (p)

2,380

PV of FY22 fair value per share (p)

2,163

Fair value of P/BV FY21 (x)

1.42

P/BV FY21 (x)

0.79

Source: Edison Investment Research. Note: *(ROE-g)/(COE-g).

Exhibit 13 compares STB’s market multiples with some of its peers. The valuations and forecast earnings continue to be heavily affected by the COVID-19 restrictions and economic outlook. The FY20e P/E comparisons are of limited usefulness due to the depressed earnings of the companies and the high degree of uncertainty in broker forecasts. The FY21 numbers are closer to cruising speed, but impairments are still elevated. STB is trading at a similar P/E to its peers (10.5x vs 10.3x, we remove Metrobank from the average since it is loss making). STB’s dividend yield is twice as high as the peer average. Its consensus forecast FY21 ROE is 14% lower than its peers yet it is trading on a significant P/BV discount of 30%, which is attractive from a valuation point of view.

We continue to see STB as a well-capitalised bank with a good business model that is still intact, and the FY20 results have shown that management seems to have kept a good control on asset quality. We therefore believe that market multiples suggest room for the share price to recover strongly as it starts to move back to a growth stage and earnings growth is boosted as impairments come down.

Exhibit 13: Challenger/specialist lender comparative table

Price
(p)

Market cap
(£m)

P/E (x)
FY20

P/E (x)
FY21

Dividend yield (%)

ROE (%)

FY20

ROE (%)

FY21

P/BV (x) last reported

Secure Trust Bank

1,212

225.1

14.2

10.5

3.6

6.2

7.8

0.8

Close Brothers

1621

2443.7

18.1

13.2

2.5

7.8

12.3

1.7

CYBG

197

2836.4

23.9

12.5

0.0

1.4

4.7

0.6

Metrobank

118

203.3

-0.9

-1.6

0.0

-18.3

-12.1

0.2

OneSavings Bank

468

2096.8

8.9

8.0

0.0

0.0

17.1

1.3

Paragon

477

1224.8

13.2

10.6

3.0

10.3

0.0

1.1

PCF Group

24

60.2

7.1

7.6

0.0

11.0

12.0

1.0

S&U

2310

280.3

5.1

9.9

5.2

16.8

8.3

1.5

Average ex-Metrobank

12.7

10.3

1.8

7.9

9.1

1.2

STB versus average ex-Metrobank

12%

2%

104%

-22%

-14%

-30%

Source: Refinitiv, Edison Investment Research. Note: Priced at 8 April 2021.

Exhibit 14: Recent share price performance in a peer group context, %

1 month

3 months

1 year

YTD

From 12m high

Secure Trust Bank

17.5

32.9

26.0

38.1

-3.4

Close Brothers

-3.4

11.4

56.8

17.3

-4.8

CYBG

2.2

40.5

166.8

46.5

-2.1

Metrobank

-8.9

-12.0

30.1

-15.8

-27.7

OneSavings Bank

4.6

6.0

102.1

10.6

-0.8

Paragon

1.9

-1.8

45.2

-2.4

-5.5

PCF Group

-4.0

-7.7

20.0

-20.0

-24.6

S&U

3.6

5.0

38.1

2.2

-3.8

Average

-0.6

5.9

65.6

5.5

-9.9

STB versus average

18

27

-40

33

6

Source: Refinitiv, Edison Investment Research. Note: Priced at 8 April 2021.

Financials

Following the 6.2% ROE in FY20, we are estimating ROEs of 7.8% in FY21 and 11.1% in FY22. We estimate that STB’s PBT will rise from £20.1m (FY20) to £27.4m (FY21) and then £41.5m (FY22).

The decline of loan impairments from their cyclically elevated levels will be a significant driver of the increase in earnings as the they are modelled to decline from 2.7% of loans to 1.5% in FY22.

We are assuming interest margins remain relatively stable in FY21 and FY22 and net interest income will therefore be mostly driven by balance sheet expansion in the coming years. We are estimating a small decrease in net interest income (-3%) in FY21 as a carry-on effect from the contraction of the lockdown. We estimate an 14% increase y-o-y for net interest income in FY22.

Net fees will pick up more noticeably than interest income as new business volumes pick up. We forecast fee growth of 23% and 21% for FY21 and FY22. We are assuming a cost to income ratio of 60.8% in FY21 and 57.0% in FY22 with the rise in operating expenses in FY21 reflecting STB investing for growth.

We estimate that the CET1 ratio will move from 14.2% (FY20) to 12.8% (FY22) with a 40% dividend pay-out ratio assumption. The bank’s capital position therefore is expected to remain strong and clearly STB can afford to grow more than we are estimating should management choose. STB’s relatively good profitability and its high capital starting point of 14.2% permits this flexibility to comfortably grow the balance sheet.

Exhibit 15: Financial summary

Year end December (£m except where stated)

2018

2019

2020

2021e

2022e

Profit and loss

Net interest income

133.7

145.4

150.9

147.0

168.2

Net commission income

17.9

20.1

15.2

18.7

22.6

Total operating income

151.6

165.5

166.1

165.7

190.8

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

(84.5)

(94.2)

(91.6)

(100.7)

(108.8)

Operating profit pre impairments & exceptionals

67.1

71.3

74.5

65.0

82.1

Impairment charges on loans

(32.4)

(32.6)

(51.3)

(37.7)

(40.5)

Losses on modification of financial assets

0.0

0.0

(3.1)

0.0

0.0

Profit before tax

34.7

38.7

20.1

27.4

41.5

Corporation Tax

(6.4)

(7.6)

(3.9)

(5.7)

(8.7)

Tax rate

18.4%

19.6%

19.4%

21.0%

21.0%

(Loss)/profit for year

28.3

31.1

16.2

21.6

32.8

Minority interests

0.0

0.0

0.0

0.0

0.0

Net income attributable to equity shareholders

28.3

31.1

16.2

21.6

32.8

Company reported pre-tax earnings adjustments

2.0

2.4

0.0

0.0

0.0

Reported underlying earnings after tax

29.9

33.5

16.2

21.6

32.8

Average basic number of shares in issue (m)

18.5

18.5

18.6

18.6

18.6

Average diluted number of shares in issue (m)

18.6

18.6

18.8

18.8

18.8

Reported diluted EPS (p)

152.2

167.3

85.2

115.2

175.0

Underlying diluted EPS (p)

161.0

180.2

85.2

115.2

175.0

Ordinary DPS (p)

83.0

87.2

44.0

46.1

70.0

Special DPS (p)

0.0

0.0

0.0

0.0

0.0

Net interest/average loans

7.32%

6.44%

6.32%

6.15%

6.30%

Impairments incl losses on loan modifications /average loans

1.79%

1.46%

2.26%

1.56%

1.52%

Cost income ratio

55.7%

56.9%

55.1%

60.8%

57.0%

Balance sheet

Net customer loans

2,028.9

2,450.1

2,358.9

2,480.0

2,860.0

Other assets

415.4

232.7

305.2

275.6

317.8

Total assets

2,444.3

2,682.8

2,664.1

2,755.6

3,177.8

Total customer deposits

1,847.7

2,020.3

1,992.5

2,066.7

2,383.3

Other liabilities

359.5

408.4

401.1

405.0

486.3

Total liabilities

2,207.2

2,428.7

2,393.6

2,471.6

2,869.6

Net assets

237.1

254.1

270.5

283.9

308.2

Minorities

0.0

0.0

0.0

0.0

0.0

Shareholders' equity

237.1

254.1

270.5

283.9

308.2

Reconciliation of movement in equity

Opening shareholders' equity

249.1

237.1

254.1

270.5

283.9

Profit in period

28.1

31.1

16.2

21.6

32.8

Other comprehensive income

(25.8)

0.0

(0.2)

0.0

0.0

Ordinary dividends

(14.8)

(15.5)

0.0

(8.2)

(8.6)

Special dividend

0.0

1.2

0.0

0.0

0.0

Share based payments

0.5

0.3

(0.7)

0.0

0.0

Issue of shares

0.0

0.0

1.1

0.0

0.0

Share issuance costs

0.0

0.0

0.0

0.0

0.0

Closing shareholders' equity

237.1

254.1

270.5

283.9

308.2

Other selected data and ratios

Period end shares in issue (m)

18.5

18.5

18.6

18.6

18.6

NAV per share (p)

1,283

1,375

1,453

1,525

1,655

Tangible NAV per share (p)

1,230

1,326

1,412

1,492

1,626

Return on average equity

11.6%

12.7%

6.2%

7.8%

11.1%

Normalised return on average equity

12.3%

13.6%

6.2%

7.8%

11.1%

Return on average TNAV

13.3%

14.8%

6.7%

8.8%

12.9%

Average loans

1,826.4

2,258.9

2,389.0

2,391.0

2,670.0

Average deposits

1,655.4

1,967.8

2,010.3

2,002.8

2,225.0

Loans/deposits

109.8%

121.3%

118.4%

120.0%

120.0%

Risk exposure

1,824.6

2,118.1

2,001.5

2,206.0

2,540.5

Common equity tier 1 ratio

13.8%

12.7%

14.2%

13.6%

12.8%

Source: Secure Trust Bank, Edison Investment Research

Contact details

Revenue by geography

One Arleston Way
Shirley, Solihull
West Midlands
B90 4LH, UK

+44 121 693 9100
www.securetrustbank.com

Contact details

One Arleston Way
Shirley, Solihull
West Midlands
B90 4LH, UK

+44 121 693 9100
www.securetrustbank.com

Revenue by geography

Management team

Chairman: The Rt Hon Lord Forsyth

CEO: David McCreadie

Michael Forsyth served in government for 10 years and as an MP for 14 years before joining the House of Lords in 1999. A director of J&J Denholm and Denholm logistics, he has also held a number of other directorships. Lord Forsyth was appointed to the board in 2014 and as chairman in October 2016.

David McCreadie was appointed to the board on 17 December 2019 and appointed CEO, subject to regulatory approval, on 5 January 2021. Previously he was an executive director and managing director of Tesco Bank, with a responsibility for the banking and insurance businesses, from 2015 to 2019. David joined Tesco Personal Finance in 2008 and was a member of the executive team that built Tesco Bank. He was previous CEO of Kroger Personal Finance and spent 22 years at The Royal Bank of Scotland (RBS) holding roles in branch banking, consumer finance and several group central functions.

CFO: Rachel Lawrence

Rachel Lawrence was appointed as CFO in May 2020. She has considerable experience in finance and banking start-ups gained from a career spanning more than 20 years. She has held senior finance roles at Metro Bank, Shawbrook and Pearl Assurance. Her previous position was at AIB Group (UK), where she held the position of CFO since 2016. She is a qualified chartered management accountant.

Management team

Chairman: The Rt Hon Lord Forsyth

Michael Forsyth served in government for 10 years and as an MP for 14 years before joining the House of Lords in 1999. A director of J&J Denholm and Denholm logistics, he has also held a number of other directorships. Lord Forsyth was appointed to the board in 2014 and as chairman in October 2016.

CEO: David McCreadie

David McCreadie was appointed to the board on 17 December 2019 and appointed CEO, subject to regulatory approval, on 5 January 2021. Previously he was an executive director and managing director of Tesco Bank, with a responsibility for the banking and insurance businesses, from 2015 to 2019. David joined Tesco Personal Finance in 2008 and was a member of the executive team that built Tesco Bank. He was previous CEO of Kroger Personal Finance and spent 22 years at The Royal Bank of Scotland (RBS) holding roles in branch banking, consumer finance and several group central functions.

CFO: Rachel Lawrence

Rachel Lawrence was appointed as CFO in May 2020. She has considerable experience in finance and banking start-ups gained from a career spanning more than 20 years. She has held senior finance roles at Metro Bank, Shawbrook and Pearl Assurance. Her previous position was at AIB Group (UK), where she held the position of CFO since 2016. She is a qualified chartered management accountant.

Principal shareholders

(%)

St James Place

13.7%

Invesco

9.7%

30 St Investment

8.1%

Unicorn Investment Funds

7.7%

Fidelity International (FIL)

6.2%

Premier Miton Group

5.9%

Arbuthnot Banking Group

5.7%

Wellington

5.0%


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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 research department of Edison 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.

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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.

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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

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

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

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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Research: Investment Companies

Lowland Investment Company — Positioned to benefit from UK recovery

Lowland Investment Company (LWI) is riding high among its UK Equity Income peers over 12 months as a market rotation towards more cyclical and domestic UK names looks to vindicate its valuation-aware, multi-cap approach. With the Brexit withdrawal agreement now signed, managers James Henderson and Laura Foll say an increase in takeover activity shows private equity and trade buyers see the value in UK companies, and argue that international investors should also return to a market that has got used to being seen as ‘unloved and underperforming’. After almost a decade of adding to its revenue reserve each year, LWI was able to draw on this to increase its FY20 dividend, with sufficient firepower to do so again in FY21 even if UK corporate dividends take longer than anticipated to recover.

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