Secure Trust Bank — Update 16 June 2016

Incorporated in 1954, Secure Trust (STB) is a well-established specialist lender, which, since 1985, has been a subsidiary of Arbuthnot Banking Group (ARBB). Secure Trust was floated on AIM in 2011 and in 2012 it acquired the Everyday Loans Group (unsecured personal lending). Then, in 2013, it purchased V12 Finance Group (point of sale retail loans) and the assets of Debt Managers Group (debt collection services). STB has traditionally focused on the provision of banking services to customers who may not have been well serviced by the large incumbent banks. The scope of business has progressively broadened in recent years from consumer unsecured lending to include motor, retail point of sale and business finance (which includes real estate finance, invoice discounting, factoring and asset finance).

In the years since the financial crisis the pace of STB’s loan growth has been rapid (64% annual compound 2010-15) focused in particular on secured lending. Exhibit 1 shows the progression and segmental analysis of customer lending. Furthering the trend to secured lending, the sale of Everyday Loans Group was announced last year and completed in April this year, generating a profit of £115m that supports the proposed payment of a special dividend of 165p (£30m) and provides substantial capital headroom (estimated pro forma common equity tier 1 ratio – CET1 – of 24%). Management has indicated that it aims to achieve three broadly equal legs to the business: consumer, business and mortgage lending.

In May 2016, ARBB announced the conditional sale of shares in STB to institutional shareholders, prospectively taking its shareholding from 51.9% to below 20%. The sale was priced at £25, a 10.7% discount to the closing price the day before the announcement. Following approval of the sale of shares at the ARBB general meeting this week, the sale will complete leaving the former parent as an 18.9% shareholder in STB. ARBB has undertaken not to sell further STB shares unless agreed by the book runner, Stifel.

The group has confirmed that, following completion of the share sale, it will seek to move from AIM to a premium listing on the Main Market of the London Stock Exchange. In order to address the corporate governance structure as part of this process, the chairman of STB and chief executive of ARBB, Sir Henry Angest, has indicated that he intends to initiate a search for a new independent non-executive chairman for STB. The move is likely to take between three and six months.

The combination of STB’s change in status from being a quoted subsidiary and the move to the Main Market should enhance the company’s ability to issue equity by widening the potential investor audience. This in turn would broaden the range of strategic options for STB should an appropriate opportunity present itself.

In this respect, STB might arguably have greater flexibility than some of its peers. Among the specialist/challenger peers included in our comparative table (Exhibit 4), a number have significant strategic stakes that might be regarded as an overhang or complication were share issuance to be contemplated; Aldermore, Arbuthnot Banking Group, Metrobank, OneSavings Bank, Private & Commercial Finance, S&U and Shawbrook all have strategic shareholdings greater than 40% (source Thomson Reuters).

Our existing forecasts assume a continued rapid pace of organic loan growth at STB reflecting the favourable opportunity that exists for specialist lenders to address areas of the market that are non-core for the large incumbent banks. As shown in Exhibit 3, we assume ex-ELG customer loans grow from £961m in 2015 to £2,578m in 2018. (For further discussion of the market outlook and our estimates see our note Growing into its capital, 26 April 2016.)

In addition to the organic opportunity, which on our forecasts to end 2018 can be met with existing capital resources, the expansion in the number of challenger and specialist lenders in the UK market increases the potential for value-accretive M&A activity. This could provide scale efficiencies and shareholder value for participants.

STB’s name has been linked with Williams & Glyn and the Co-op Bank, for example, and STB’s Paul Lynam has been quoted in the Financial Times saying that the company would be interested in exploring whether Williams & Glyn would represent an opportunity, “alongside other things we review from time to time”. The apparent challenges in separating Williams & Glyn systems from parent RBS suggests this exploration may not take place in the near term.

STB’s management has not set out characteristics of a target it would consider, although it emphasises the importance of considering the balance of risk and reward when assessing the valuation of a potential purchase. We would also expect management to take account of any opportunity to diversify and lower the cost of funding while maintaining or increasing the breadth of exposures within the loan book. The existing and developing areas of expertise within STB span retail and commercial markets as indicated by the loan book analysis in Exhibit 3. In addition to this, the experience of Chief Executive Paul Lynam and Chief Financial Officer Neeraj Kapur are relevant. Lynam spent 22 years at NatWest and RBS before joining STB in 2010 with responsibilities that included running the SME banking business across the UK and four years as managing director of Lombard North Central (the largest finance and leasing business in Europe). Kapur spent 11 years in professional practice before joining RBS in 2001 and his roles included CFO at Lombard North Central; he joined the STB board in 2011.

We have not changed our valuation calculation, which, based on an ROE/COE model, indicates a value of c 3,600p. Our assumptions include a cost of equity of 10%, nominal growth of 5% and a return on equity of 19% (similar to our estimate for 2018).

For reference we have refreshed our comparative table (Exhibit 4). STB trades at an above-average price to book, but also has an above-average historical ROE and yield.

A comparison of P/NAV versus ROE (Exhibit 5) shows STB broadly ‘in the pack’. Prospective growth for STB and the group’s ability to regain the historical return on equity of over 20% as it redeploys the capital released by the sale of ELG will be key drivers of future performance. The valuation of Metrobank is an obvious example of the market’s willingness to apply a multiple reflecting prospective profitability (management targets a return on equity of 20%). For STB the additional strategic flexibility that it will enjoy as an independent company with a listing on the Main Market broadens the scope for accretive M&A activity (although any transaction would also carry normal pricing and implementation risks).