Secure Trust Bank |
Upbeat trading update |
Trading update |
Banks |
21 May 2019 |
Share price performance
Business description
Next events
Analysts
Secure Trust Bank is a research client of Edison Investment Research Limited |
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Secure Trust Bank’s (STB) trading update seems to vindicate its decision to step away from mortgages for now and focus on segments where the risk-reward pricing is more attractive. The retail and motor finance segments (both with net revenue margins above 10%) have been doing well and earnings are slightly ahead of management expectations in the first four months of this year. We are not changing our forecasts, but may revise them if interims in July confirm the good news.
Year end |
Operating income (£m) |
PBT* |
EPS* |
DPS |
P/E |
Yield |
12/17 |
129.5 |
27.0 |
116.4 |
79.0 |
13.3 |
5.1 |
12/18 |
151.6 |
36.7 |
162.0 |
83.0 |
9.5 |
5.4 |
12/19e |
167.8 |
42.0 |
183.7 |
87.2 |
8.4 |
5.6 |
12/20e |
185.0 |
52.2 |
225.1 |
91.5 |
6.9 |
5.9 |
12/21e |
203.5 |
60.1 |
254.9 |
92.6 |
6.1 |
6.0 |
Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.
Risk-reward benefits
The retail and motor finance segments have the highest net revenue margins (after impairments) in STB’s portfolio. The trading update indicates that these two areas are growing well and boosting earnings. STB’s decision to stand back temporarily from mortgage lending was a bold one, since mortgages had been slated as one of the legs for growth in the bank. However, management felt that as competition increased in the mortgage segment, what was intended as a defensive segment was becoming more problematic. Lower margins not only mean lower profitability, but also increase operational gearing and earnings risk. STB has not changed its risk appetite (it remains wary of the macro outlook), but seems to be finding risk-adjusted margins in selected, unsecured segments more profitable.
Funding advantage
STB’s balance sheet comments were very positive. Credit quality trends are stable, while capital and funding positions remain strong. This balance sheet strength has helped STB gain business so far this year at the expense of some non-bank lending competitors that have struggled with funding, in some cases even ceasing new business. The company believes the continued unwinding of the Funding for Lending and Term Funding schemes may lead to more non-bank lenders facing similar problems, to STB’s advantage.
Valuation: Unchanged at 2,428p
We make no changes to our forecasts and maintain our fair value at 2,428p per share (based on a dividend discount model), equivalent to a 2019 P/NTA of 1.9x. STB’s shares are up 22% ytd, but the bank’s P/NTA is still trading at only 1.1x. We believe that if STB continues to perform well in the next two months, the interim results in July should reflect this and we may revise our numbers.
Risk-reward benefits
STB announced a mortgage hiatus at the beginning of this year. This was a bold step given that STB had chosen mortgages as one of the legs for future growth. Furthermore, this was part of the general balance sheet de-risking strategy as STB grew more concerned with macro uncertainty resulting from Brexit and the evidence of a general slowdown.
Several banks (including some larger players) have been increasing competitive efforts in the mortgage market, largely due to the lower risk profile of mortgages. This has led to some margin compression, especially in the higher-margin segment of the sector (such as higher LTV, lower borrower quality). Management’s view is that this is not attractive on a risk adjusted basis. STB believes that this made profitability in this segment more challenging and, paradoxically, also meant higher earnings risk, especially if the economic slowdown became more severe than expected.
In the first four months of this year, the retail finance and motor finance divisions performed well and this seems to be behind the upbeat trading update. The retail finance and motor finance net revenue margins were 10.3% and 15.3% in 2018, respectively, the highest-margin segments in their loan book (mortgages was 2.6%). STB is still following a cautious risk strategy (eg motor finance has been migrating from subprime to near-prime), but at the same time is looking at its risk-adjusted margins carefully and altering its lending direction accordingly.
By way of comparison, CYBG announced its 2019 interims on 15 May, and we note that its six-month net interest margin dropped to 1.71% from 1.84% a year ago. Mortgage lending accounted for 11bp out of this 13bp contraction. While 11bp may seem small at first glance, it is significant at 7% of net interest income. We also note that CYBG indicated that margin pressures would likely remain and that it would proactively reduce its lending in certain mortgage segments as a result of margin compression and competition. Tesco also just announced that it is looking for a buyer for its mortgage portfolio and ceasing new business, quoting ‘challenging market conditions’.
Forecasts unchanged
We are keeping our forecasts unchanged despite the upbeat trading update. However, the interims in July may give us reason to revise our numbers.
We forecast loan growth of 20% y-o-y in 2019, stronger in commercial finance (26% y-o-y) than retail lending (15%). We expect growth to be balanced between the two areas in 2020 and 2021.
We continue to expect that some cost investments and one-offs will push the cost/income ratio up from 55.7% in 2018 to 58% in 2019. This will offset some of the benefits from the lower loan loss charge and volume growth. We forecast PBT on a continuing basis to rise from £34.7m in 2018 to £40.2m in 2019.
We forecast the cost to income ratio to improve from 2020 onwards, falling to 56% in 2020 and then 54.5% in 2021.This will be driven by balance sheet growth and the benefits of operating leverage and use of capital. We see pre-tax earnings on a continuing basis rising from £40m to £50m in 2020 and then to £60m in 2021.
We forecast the bank’s ROE will increase from 12.8% in 2018 to 18.7% in 2021. By 2021, the bank’s CET1 will have dropped to 11% which, although an acceptable level of capital, would require growth beyond 2021 to be funded by self-generated capital.
Valuation
STB’s shares have risen by 22.3% ytd. However, the bank was trading below its tangible net assets. This means the shares are now at a 2019 P/NTA of only 1.1x, while our fair value at (2,428p) remains at a P/NTA 1.9x (forecast tangible net asset of 1,298p). Our fair value is derived using a dividend discount model. Note that we forecast a ROTE of 18.0% in 2020 and 19.8% in 2021, hence a fair value well in excess of tangible book value is fully justified in our view.
Exhibit 1: Recent share price performance in context
One month |
Three months |
One year |
Ytd |
From 12m high |
|
Secure Trust Bank |
-8.5 |
8.2 |
-26.1 |
22.3 |
-27.1 |
1PM |
0.0 |
-5.4 |
-9.8 |
7.3 |
-29.9 |
Close Brothers |
-3.8 |
0.7 |
-3.9 |
4.3 |
-10.7 |
CYBG |
-8.0 |
4.2 |
-35.2 |
9.0 |
-46.2 |
Metrobank |
-30.5 |
-57.1 |
-82.6 |
-65.5 |
-83.4 |
OneSavings Bank |
-3.5 |
17.1 |
2.9 |
23.0 |
-6.1 |
Paragon |
0.5 |
10.4 |
-15.3 |
19.7 |
-17.2 |
PCF Group |
3.9 |
-9.4 |
-20.3 |
-8.6 |
-24.8 |
S&U |
20.2 |
2.6 |
-20.7 |
1.9 |
-22.2 |
Average |
-2.6 |
-4.6 |
-23.1 |
-1.1 |
-30.1 |
Average ex-Metro |
1.3 |
2.9 |
-14.6 |
8.1 |
-22.5 |
Source: Refinitiv, Edison Investment Research. Note: Priced at 15 May 2019.
Exhibit 2 compares STB’s market multiples with some of its challenger and specialist lender peers. Excluding the outlier Metro Bank, STB’s 2018 and 2019 P/E ratios are in line with the peer average. It is trading on a 2018 PBV of 1.1x, which is 15% below its peers. Its ROE of 9.8% is 32% below its peers since optically on this metric it does not look comparatively good value. However, we expect STB to have a significant uplift in profitability in 2020 (ROE of 17.1%) and then reach 18.7% in 2021. On this basis, it would suggest that the 15% discount looks attractive.
We reiterate our view that, as the market gains confidence that STB’s repositioning is indeed working, this will be reflected in its rating. If STB continues to do as well as it indicated in the trading update, we believe the interims in July will support this view.
Exhibit 2: Challenger/specialist lender comparative table
Price |
Market cap |
P/E (x) |
P/E (x) |
Dividend yield (%) |
ROE (%) last reported |
P/BV (x) last reported |
|
Secure Trust Bank |
1,455 |
270.0 |
9.0 |
7.9 |
5.7 |
9.8 |
1.12 |
1PM |
44 |
38.7 |
6.0 |
5.5 |
1.5 |
13.0 |
1.00 |
Close Brothers |
1,502 |
2283.1 |
11.0 |
10.9 |
4.2 |
16.3 |
1.69 |
CYBG |
198 |
2844.2 |
7.6 |
7.9 |
1.6 |
10.6 |
0.55 |
Metrobank |
584 |
571.4 |
13.9 |
18.4 |
0.0 |
2.9 |
0.41 |
OneSavings Bank |
431 |
1060.2 |
8.0 |
7.0 |
3.4 |
22.3 |
1.55 |
Paragon |
462 |
1211.5 |
9.5 |
8.9 |
4.2 |
10.3 |
1.19 |
PCF Group |
33 |
82.9 |
15.4 |
10.4 |
0.9 |
11.0 |
1.65 |
S&U |
2,170 |
262.5 |
6.4 |
5.7 |
3.1 |
17.6 |
1.68 |
Average |
9.7 |
9.3 |
2.4 |
13.0 |
1.21 |
||
Average ex-Metro |
9.1 |
8.0 |
2.7 |
14.4 |
1.3 |
||
STB vs average ex-Metro |
(2%) |
(1%) |
112% |
-32% |
-15% |
Source: Refinitiv, Edison Investment Research. Note: Priced at 15 May 2019.
Exhibit 3: Financial summary
Year-end December |
2016 |
2017 |
2018 |
2019e |
2020e |
2021e |
£m except where stated |
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PROFIT AND LOSS |
||||||
Net interest income |
92.5 |
114.6 |
133.7 |
148.5 |
162.1 |
177.8 |
Net commission income |
14.5 |
14.9 |
17.9 |
19.3 |
22.8 |
25.7 |
Total operating income |
107.0 |
129.5 |
151.6 |
167.8 |
185.0 |
203.5 |
Total G&A expenses (exc non-recurring items below) |
(64.3) |
(71.3) |
(84.5) |
(97.3) |
(103.5) |
(110.9) |
Operating profit pre impairments & exceptionals |
42.7 |
58.2 |
67.1 |
70.5 |
81.5 |
92.7 |
Impairment charges on loans |
(23.3) |
(33.5) |
(32.4) |
(30.3) |
(31.2) |
(32.5) |
Other income |
0.0 |
0.3 |
0.0 |
0.0 |
0.0 |
0.0 |
Operating profit post impairments |
19.4 |
25.0 |
34.7 |
40.2 |
50.3 |
60.1 |
Non-recurring items |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Pre-tax profit - continuing basis |
19.4 |
25.0 |
34.7 |
40.2 |
50.3 |
60.1 |
Corporation Tax |
(5.2) |
(5.1) |
(6.4) |
(6.8) |
(8.5) |
(10.2) |
Tax rate |
26.8% |
20.4% |
18.4% |
17.0% |
17.0% |
17.0% |
Bank tax surcharge |
0.0 |
0.0 |
0.0 |
(1.2) |
(2.0) |
(2.8) |
Profit after tax - continuing basis |
14.2 |
19.9 |
28.3 |
32.1 |
39.7 |
47.1 |
Discontinued business |
123.3 |
3.9 |
0.0 |
0.0 |
0.0 |
0.0 |
(Loss)/profit for year |
137.5 |
23.8 |
28.3 |
32.1 |
39.7 |
47.1 |
Minority interests |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Net income attributable to equity shareholders |
137.5 |
23.8 |
28.3 |
32.1 |
39.7 |
47.1 |
Company reported pre-tax earnings adjustments |
7.9 |
2.0 |
2.0 |
1.8 |
1.9 |
0.0 |
Reported underlying pre-tax earnings (ex-discontinued 2015/16) |
27.3 |
27.0 |
36.7 |
42.0 |
52.2 |
60.1 |
Reported underlying earnings after tax |
20.6 |
21.5 |
29.9 |
33.9 |
41.6 |
47.1 |
Average basic number of shares in issue (m) |
18.5 |
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 |
18.6 |
Reported diluted EPS (p) |
77.3 |
107.0 |
152.2 |
172.9 |
213.6 |
253.4 |
Underlying diluted EPS (p) |
113.0 |
116.4 |
162.0 |
183.7 |
225.1 |
254.9 |
Ordinary DPS (p) |
75.0 |
79.0 |
83.0 |
87.2 |
91.5 |
92.6 |
Special DPS (p) |
165.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Net interest/average loans |
8.15% |
7.72% |
7.37% |
6.67% |
6.15% |
5.84% |
Impairments/average loans |
2.04% |
2.30% |
1.79% |
1.36% |
1.18% |
1.07% |
Cost income ratio |
60.1% |
55.1% |
55.7% |
58.0% |
56.0% |
54.5% |
BALANCE SHEET |
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Net customer loans |
1,321.0 |
1,598.3 |
2,028.9 |
2,428.5 |
2,841.4 |
3,249.6 |
Other assets |
189.0 |
293.3 |
415.4 |
428.6 |
443.5 |
485.6 |
Total assets |
1,510.0 |
1,891.6 |
2,444.3 |
2,857.0 |
3,284.9 |
3,735.2 |
Total customer deposits |
1,151.8 |
1,483.2 |
1,847.7 |
2,248.6 |
2,583.1 |
3,008.9 |
Other liabilities |
122.2 |
159.3 |
359.5 |
354.7 |
424.6 |
411.7 |
Total liabilities |
1,274.0 |
1,642.5 |
2,207.2 |
2,603.3 |
3,007.7 |
3,420.6 |
Net assets |
236.0 |
249.1 |
237.1 |
253.7 |
277.2 |
314.6 |
Minorities |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
Shareholders' equity |
236.0 |
249.1 |
237.1 |
253.7 |
277.2 |
314.6 |
Other selected data and ratios |
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Period end shares in issue (m) |
18.5 |
18.5 |
18.5 |
18.5 |
18.5 |
18.5 |
NAV per share (p) |
1,277 |
1,348 |
1,283 |
1,373 |
1,500 |
1,703 |
Tangible NAV per share (p) |
1,229 |
1,292 |
1,230 |
1,298 |
1,425 |
1,638 |
Return on average equity |
72.9% |
9.8% |
11.6% |
13.1% |
15.0% |
15.9% |
Normalised return on average equity |
9.9% |
8.9% |
12.8% |
14.4% |
17.1% |
18.7% |
Return on average TNAV |
10.3% |
9.3% |
13.4% |
15.1% |
18.0% |
19.8% |
Average loans |
1,134.6 |
1,484.6 |
1,863.7 |
2,228.7 |
2,430.1 |
2,635.0 |
Average deposits |
1,067.5 |
1,321.7 |
1,655.4 |
2,085.3 |
2,264.9 |
2,427.8 |
Loans/deposits |
114.7% |
107.8% |
109.8% |
108.0% |
110.0% |
108.0% |
Risk exposure |
1,264.0 |
1,446.1 |
1,824.6 |
2,175.8 |
2,522.0 |
2,878.9 |
Common equity tier 1 ratio |
18.0% |
16.5% |
13.8% |
12.0% |
11.1% |
11.0% |
Source: Edison Investment Research, company data
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