Secure Trust Bank — V12 Retail Finance to support refreshed targets

Secure Trust Bank (LSE: STB)

Last close As at 21/05/2024

GBP8.08

26.00 (3.32%)

Market capitalisation

GBP142m

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Research: Financials

Secure Trust Bank — V12 Retail Finance to support refreshed targets

In its Q323 trading update, Secure Trust Bank (STB) posted 1.7% q o q growth in net lending alongside 2.6% growth in its deposits. This was despite a 7% fall in new business lending from an elevated Q223 comparable as consumer spending weakened. More importantly, STB also hosted a capital markets day (CMD), where management reiterated the medium-term 14–16% return on average equity (RoAE) target and presented on the V12 Retail Finance business in detail. The RoAE should be supported by an improved mix weighted towards Retail Finance, combined with moderated volume growth and greater cost efficiency. Project Fusion is developing well and has now been extended to deliver annualised savings of £5m by the end of FY24. We have only changed our estimates for the issue of 0.2m shares under the employee share plan.

Written by

Robert Murphy

Managing Director, Financials and Investment Trusts

Secure-Trust-Bank_resized

Financials

Secure Trust Bank

V12 Retail Finance to support refreshed targets

Q323 update and CMD

Banks

21 November 2023

Price

648p

Market cap

£123m

CET1 ratio at H123

13.0%

Shares in issue

18.9m

Free float

91%

Code

STB

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

3.2

(3.6)

(0.3)

Rel (local)

0.8

(6.5)

(1.0)

52-week high/low

802p

550p

Business description

Secure Trust Bank is a well-established specialist bank addressing niche markets within consumer and business lending.

Next events

FY23 results

March 2024

Analysts

Rob Murphy

+44 (0)20 3077 5700

Armando Hoxha

+44 (0)20 3077 5700

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

In its Q323 trading update, Secure Trust Bank (STB) posted 1.7% qoq growth in net lending alongside 2.6% growth in its deposits. This was despite a 7% fall in new business lending from an elevated Q223 comparable as consumer spending weakened. More importantly, STB also hosted a capital markets day (CMD), where management reiterated the medium-term 14–16% return on average equity (RoAE) target and presented on the V12 Retail Finance business in detail. The RoAE should be supported by an improved mix weighted towards Retail Finance, combined with moderated volume growth and greater cost efficiency. Project Fusion is developing well and has now been extended to deliver annualised savings of £5m by the end of FY24. We have only changed our estimates for the issue of 0.2m shares under the employee share plan.

Year end

Operating income (£m)

PBT*
(£m)

EPS**
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/21

148.9

55.9

239.4

61.1

2.7

9.4

12/22

169.6

39.0

174.7

45.1

3.7

7.0

12/23e

188.5

45.0

167.7

42.0

3.9

6.5

12/24e

221.8

55.0

212.4

53.7

3.1

8.3

Note: *PBT from continuing operations. **Fully diluted.

Loan growth boosted by Commercial

The overall 1.7% q-o-q loan growth represents a deceleration compared to the 14.2% y-o-y figure as new lending dropped 7% from very strong Q223 levels and the economic backdrop remains challenging. Consumer Finance grew 1% q-o-q and Real Estate lending was flat. More positively, Commercial Finance delivered strong loan book growth, rising 16.4% q-o-q on greater lead conversion. This growth profile appears more in line with the new £4bn medium-term loan book target, which implies a high single-digit compound annual growth rate (CAGR) in the loan book over the next three years or so.

STB’s refreshed medium-term targets

STB has maintained its key medium-term financial targets: a RoAE of 14–16%, based on a net interest margin >5.5% and a common equity tier 1 (CET1) capital ratio >12%. However, these are to be achieved with lower volume growth and greater cost efficiency (see below). Effectively, STB is managing for return by shifting the mix towards higher risk-adjusted margin business (V12 Retail Finance) that can still grow, take market share and benefit from continuing scale efficiencies. Easing off on volume growth should also contribute towards profitability by reducing upfront IFRS 9 provisioning requirements and new business origination costs.

Valuation: Still undervalued compared to peers

Based on our FY23 estimates, STB trades at a diluted price to book value (P/BV) of 0.36x and a P/E of only 3.9x. To trade in line with peers, the implied valuation for STB should be closer to c 0.6x or c 1,000p/share, representing an upside of 55%. Assuming STB delivers on its 14–16% RoAE target, has a lending book of c £4bn and achieves its cost targets, we would expect it to trade closer to book value.

Capital markets day summary

At its CMD, management refreshed STB’s medium-term targets. The overall RoAE, net interest margin and capital ratio targets are unchanged, but volume growth and the cost-income ratio (CiR) have been revised. The previous 15% CAGR target on its loan book has now been replaced with an absolute target of c £4bn over the medium term, which implies a high single-digit CAGR over the next three years. Offsetting the lower projected volume, the CiR target has been upgraded from less than 50% to 44–46% (see Exhibits 1 and 2). STB also delved into V12 Retail Finance, presented by Nick Davies (CEO) and Andrew Phillips (commercial director) of V12.

Implicitly, the RoAE target depends on scale and capital allocation. The expansion of V12 within the mix will play an important role in achieving a high risk-adjusted return overall. Thus, the ultimate credit quality at V12 is a key factor in profitability and currently probably an uncertainty holding back the valuation of the group during a difficult economic environment. In this regard, management addressed the question of how unsecured ‘interest-free’ lending within Retail Finance should be of higher quality than other, more popular forms of lending such as personal loans and credit cards. In particular, retail customers using interest-free lending often do not actually need to rely on credit to make a purchase, but value the ability to defer payments without additional cost.

The path to RoAE of 14–16%

Following successive growth in its lending book – 45% over the last 30 months – management no longer believes it needs to grow its lending at a 15% CAGR to achieve its RoAE target of 14–16%. The bank is focused on managing for risk-adjusted return, but the £4bn target loan book still leaves room for solid growth from the Q323 level of £3.2bn. In FY22 and H123, the loan impairment rate or cost of risk (CoR) in V12 was 1.6%, far below the pre-pandemic figure of 3.0% in 2019, as STB has tightened credit standards and shifted to more prime ‘interest-free’ lending – 90% of new business and 86% of receivables in V12 at H123. STB views this as a structural shift and projects an across-the-cycle group CoR of 1.3–1.5%, which should benefit medium-term returns. The market will likely adopt a ‘wait-and-see’ stance on CoR in the very near term, but successful execution here would be a major driver of a re-rating in the shares, in our view.

Underpinning the pathway to the RoAE target are STB’s cost efficiency initiatives and scalable digital platform. Project Fusion has now been extended to deliver c £5m in annualised savings by end-FY24, an additional £1m over the £4m targeted for FY23. Administrative office space has been reduced by just over 50% and the bank plans to reduce some of its more expensive office space in London. Digitisation has boosted operational efficiency and simultaneously reduced costs. STB recently launched its savings account mobile app that allows users to access their account and transfer money, which has reduced the number of calls to its call centre. Notably, the proprietary platform in V12 Retail Finance has enabled average staff numbers to fall slightly since 2019 while the loan book has grown by 70%. Combined with continued lending growth, the bank should generate improved positive operating leverage.

Exhibit 1: Previous medium-term targets

Source: Secure Trust Bank CMD presentation

Exhibit 2: New medium-term targets

Source: Secure Trust Bank CMD presentation

Management noted that for a period of time the bank will consume capital to facilitate its growth, but will then generate capital over time as it achieves its fundamental return objectives. Its capital stack remains healthy with a 13% CET1 at H123, 1pp above the 12% target and positioned to fund growth. A loan book of £4bn is still expected to result in a CET1 above 12%. The tier 2 capital raise in February this year has enlarged its capability to lend by c £700m. Without the tier 2, it would have had to fund growth through its common equity, which would have resulted in a slower pace of growth.

The mix shift towards Consumer Finance business and more prime interest-free lending both has improved the credit quality of the loan book and is positioning the bank to achieve its net interest margin (NIM) targets. With the CoR in the Consumer Finance book lower than pre-COVID levels, the bank expects a through-the-cycle CoR of between 1.3% and 1.5% for the group. The bank highlights in Exhibit 3 that a book with 55% weighting towards Consumer Finance lending increases group NIM by 30bp and will help it achieve the upper bound of its NIM target range, all other things being equal (see Exhibit 3). In addition, a flattening yield curve from the current inverted one would provide an additional benefit as the loan book tends to reprice more slowly than deposits.

Exhibit 3: Net interest margin

Source: Secure Trust Bank CMD presentation

Explaining V12 Retail Finance

With balances of £1.2bn at Q223, V12 Retail Finance represents 37% of group loans, up from 30% at end FY20. The loan book has grown by 79% over the period compared to 45% for the group. The NIM is not split out from Consumer Finance as a whole, but Retail Finance now represents 73% of Consumer Finance and Exhibit 3 shows that NIMs are nearly three times those achieved in Business Finance.

V12 Retail Finance offers both interest-free and interest-bearing products to customers via retailers at the point of sale. Its most popular form of lending is interest free and in April this year V12 piloted AppToPay (with 27 retailers), a mobile app offering three-month, interest-free credit solutions for small ticket items.

The model is attractive to retail partners in that it drives incremental sales through stronger conversion rates through to checkout, while offering retail customers the flexibility of being able to spread the cost of purchases with fixed monthly payments.

V12 works by integrating its proprietary software via application programming interface links into the software of the retail partners, which then use the link to provide customers with financing options. At the point of sale, once the retail customer has applied for the credit option, V12 will perform the appropriate credit checks and provide a rapid automated credit decision, within six seconds for 90% of applications. Once the customer has purchased the product under the appropriate loan terms, V12 will send the net payment to the retailer (purchase price minus the credit charge) and receive monthly repayments direct from the customer for the purchase price. See Exhibit 4 for an illustration of the interest-free credit model.

Payment from the customer only begins once the product has been delivered. This explains why V12 sees a lag in interest rate pass-throughs. Since a large part of lending is in furniture, delivery of the product can take up to three months, meaning that only after three months from the date of initial purchase will V12 begin to receive payments. Thus, following the rapid rise in interest rates seen in the UK, margins tend to fall initially but then recover as rates are passed through to the retailer later.

Exhibit 4: Interest-free credit model

Source: Secure Trust Bank CMD presentation

Addressing concerns about the credit quality of the unsecured lending, management pointed out the correlation between the CoR falling as the interest-free lending proportion of the loan book has increased. A key feature of interest-free credit is that often the retail customer does not actually need to access credit but sees the ability to spread payments as a ‘deal’ with no additional charges. Moreover, the application process tends to self-select customers who are more confident of being accepted. Management has focused on the furniture and jewellery segments as they have proved to have the highest credit quality customers compared to lower credit quality segments such as consumer electrical products. In the past five years, V12 reduced its share in the electrical sector from 19% of volume to just over 0.3%, while it has increased its share in furniture from 20% of volume to 47% in the same period. Management further claimed that this form of lending has a better credit quality than other popular forms such as personal loans and credit cards.

Exhibit 5: Interest-free credit and cost of risk progression

Source: Secure Trust Bank CMD presentation

Since the launch of its online retail finance platform in 2001, V12 has gradually grown its market share by offering a competitive, proprietary platform and leveraging its retail partnerships. Currently, V12 has more than 1,400 retail relationships. Since 2014, it has generated new business at a strong pace, barring the COVID-19 era. Success in generating new business is contingent on the seamless integration with the retailer. Management believes V12 is favourably positioned to deliver a competitive online lending service compared to traditional banks and fintechs. V12 has the technology and nimbleness of a fintech with the banking expertise of a traditional lender (supported by STB). The unique technology allows V12 to on-board new retailers swiftly, with the ability to integrate with several retailers within a week whereas some competitors can only integrate with a few in a year, according to management.

The focus on providing a scalable digital platform has also led to cost efficiencies. In 2017, V12 launched a self-service portal that allowed customers to manage their accounts. Today, 74% of its more than one million customers use the portal. Operationally, this has been extremely efficient for V12 and has allowed it to gain operational leverage. Since 2019, calls to the customer service team reduced by 63% and in the same period the average number of (full-time) staff decreased from 230 to 224 while the loan book grew 70%.

It is worth emphasising that V12 passes on the cost of funds to the retailer, not the retailer’s customers. Currently, 60% of its retailers receive automatic quarterly pricing changes, while the remaining 40% receive immediate pricing changes. Hence, the lag effect is particularly compounded in its furniture lending where the time between the sale and receiving payment already lags (as explained above). This may also help with credit quality in a rising rate environment, although there is exposure to the underlying retailer for rate increases of course.

Thus far, growth in V12 has been strong. Additionally, it has modest concentration risk. Its largest client comprises 14% of business and only surpassed 10% of outstandings recently. With an addressable market of £10bn, there appears to be ample room for growth. At H123, it had 13.2% of market share and believes a reasonable target is in the mid-teens. Focus is on improving and growing in its current market segments, but also expanding into new lower-market share segments such as home improvements.

Valuation

In Exhibit 6 we compare STB to a peer group of mid-sized/specialist lenders in the UK. In comparison to peers and on a calendarised basis, STB trades at a far lower 2023 P/E ratio despite having a more competitive return on equity (ROE). Furthermore, with an FY24 ROE roughly in line with the peer average, STB trades at a CY24 P/E ratio of almost half the average. Alongside this, STB offers a good current dividend yield of 6.5%, slightly below the average of 6.6% as it continues to retain capital for growth. At the current price, its FY24 dividend yields 8.3%.

Exhibit 6: Peer group table

Price
(p)

Market
cap (£m)

P/E CY23e (x)

P/E CY24e (x)

ROE CY23e (%)

ROE CY24e (%)

Dividend yield (%)

Close Brothers

773

1,163

10.8

7.5

6.8

9.7

8.8

Virgin Money

168

2,246

5.5

5.1

7.0

8.0

4.9

Metrobank

40

70

11.1

4.1

1.1

3.5

N/A

OneSavings Bank

387

1,522

6.5

4.0

14.9

19.3

7.9

Paragon

495

1,082

5.8

5.5

14.1

13.9

7.0

Vanquis

114

292

15.7

5.8

6.7

11.4

5.4

S&U

2,310

282

8.9

7.8

13.2

13.9

5.8

Secure Trust Bank

648

123

3.9

3.1

9.5

11.2

6.5

Peer average

951

9.2

5.7

9.1

11.4

6.6

Source: Refinitiv, Edison Investment Research. Note: P/E and ROE are calendarised and we use our own estimates for S&U and Secure Trust Bank. Priced 17 November 2023.

Using our assumptions for FY23, STB is currently trading at a diluted P/BV of 0.36x (see Exhibit 7) and a P/E of 3.9x. STB looks highly undervalued based on our peer comparison chart where we have plotted calendarised 2023 P/BV against ROE. On a peer valuation comparison, STB should be trading closer to c 0.6x P/BV or c 1,000p/share. This implies an upside of c 55% from the current share price. Management targets an ROE of 14–16% in the medium term and, should this come to fruition, we would expect STB to trade closer to book value.

Exhibit 7: Peer group P/BV multiples versus ROE based on FY23 estimates (annualised)

Source: Refinitiv, Edison Investment Research. Note: We use our own estimates for S&U (SUS) and STB. MTRO (Metro Bank); VMUK (Virgin Money UK); CBRO (Close Brothers Group); PAGPA (Paragon Banking Group); VANQ (Vanquis Banking Group); OSBO (OneSavings Bank). Priced 17 November 2023.

Exhibit 8: Financial summary

Year-end December (£m unless stated otherwise)

2019

2020

2021

2022

2023e

2024e

Profit and loss

Net interest income

145.4

150.9

136.2

152.6

170.4

202.4

Net commission income

20.1

15.2

12.7

17.0

18.1

19.4

Total operating income

165.5

166.1

148.9

169.6

188.5

221.8

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

(94.2)

(92.6)

(89.4)

(93.2)

(101.8)

(115.3)

Operating profit pre impairments & exceptionals

71.3

73.5

59.5

76.4

86.7

106.5

Impairment charges on loans

(32.6)

(51.3)

(5.0)

(38.2)

(42.8)

(51.5)

Losses on modification of financial assets

0.0

(3.1)

1.5

1.1

0.2

0.0

Non-recurring items and other income

0.0

0.0

(0.1)

(0.3)

0.9

0.0

PBT – continuing basis

38.7

19.1

55.9

39.0

45.0

55.0

Corporation taxes

(7.6)

(3.7)

(10.4)

(9.4)

(11.2)

(13.7)

Profit after tax - continuing basis

31.1

15.4

45.5

29.6

33.7

41.2

PBT - discontinued businesses

0.0

0.0

0.1

5.0

(2.0)

0.0

Tax on discontinued businesses

0.0

0.0

0.0

(0.9)

0.5

0.0

PBT - total reported

38.7

19.1

56.0

44.0

43.0

55.0

Profit after tax - total reported

31.1

15.4

45.6

33.7

32.2

41.2

Minority interests

0.0

0.0

0.0

0.0

0.0

0.0

Net attributable income

31.1

15.4

45.6

33.7

32.2

41.2

Tax rate

20%

19%

19%

24%

25%

25%

Average basic number of shares in issue (m)

18.5

18.6

18.6

18.7

18.9

18.9

Average diluted number of shares in issue (m)

18.7

19.0

19.0

19.3

19.4

19.4

Basic reported EPS (p)

168.7

82.7

244.7

180.5

172.0

217.9

Reported diluted EPS (p)

166.7

81.0

239.4

174.7

167.7

212.4

Ordinary DPS (p)

87.2

44.0

61.1

45.1

42.0

53.7

Net interest/average loans

6.44%

6.32%

5.57%

5.60%

5.41%

5.68%

Cost of risk

1.4%

2.3%

0.1%

1.4%

1.4%

1.4%

Cost income ratio

56.9%

55.8%

60.0%

55.0%

54.0%

52.0%

Balance sheet

Net customer loans

2,450.1

2,358.9

2,530.6

2,919.5

3,380.0

3,745.0

Other assets

230.6

302.3

355.1

460.3

505.1

535.0

Total assets

2,680.7

2,661.2

2,885.7

3,379.8

3,885.1

4,280.0

Total customer deposits

2,020.3

1,992.5

2,103.2

2,514.6

2,864.4

3,200.9

Other liabilities

408.4

401.1

480.3

538.8

668.4

695.7

Total liabilities

2,428.7

2,393.6

2,583.5

3,053.4

3,532.8

3,896.5

Net assets

252.0

267.6

302.2

326.4

352.2

383.4

Minorities

0.0

0.0

0.0

0.0

0.0

0.0

Shareholders' equity

252.0

267.6

302.2

326.4

352.3

383.5

Other selected data and ratios

NAV per share (p)

1,364

1,438

1,622

1,748

1,862

2,026

Tangible NAV per share (p)

1,315

1,396

1,584

1,713

1,827

1992

Return on average equity

12.7%

5.9%

16.0%

10.7%

9.5%

11.2%

Return on average TNAV

14.8%

6.4%

18.6%

11.4%

11.9%

14.4%

Average loans

2,258.9

2,389.0

2,444.8

2,725.1

3,149.8

3,562.5

Average deposits

1,967.8

2,010.3

2,002.8

2,308.9

2,689.5

3,032.6

Loans/deposits

121%

118%

120%

116%

118%

117%

Risk exposure

2,118.1

1,999.7

2,087.4

2,335.0

2,752.7

3,079.1

Common equity tier 1 ratio

12.6%

14.0%

14.5%

14.0%

12.4%

12.0%

Source: Secure Trust Bank, Edison Investment Research


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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 £60,000 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 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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General disclaimer and copyright

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United Kingdom

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London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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