Secure Trust Bank — Solid interim results

STB’s reported loan balances grew 15% y-o-y during H122, with the figure being 23% if we include only the core lending niches excluding the businesses sold or exited (DMS, consumer mortgages and asset finance). This fast pace of growth reflects management’s medium-term target of a compound annual growth rate (CAGR) of 15% in its core lending niches and the investments made to position the bank to take advantage of the lending opportunities.

Retail finance and vehicle finance loan balances grew 32% and 37% y-o-y. Commercial finance (invoice discounting) grew 50% y-o-y. In contrast, real estate finance grew less at 8%, affected by the more delicate situation in the real estate sector.

As a small bank, it is easier for STB to gain market share in its niches than larger banks and post such strong growth numbers. Management expects a modest slowdown of growth as the economic downturn gathers pace but notes that the retail lending pipeline remains strong for Q322. STB has already made lending adjustments, including tightening lending criteria in its vehicle finance, while changing its real estate finance mix towards investment (now 88% of all loans) at the expense of the higher-yielding but riskier development loans.

Impairments in H122 came in at an annualised 1.4% of loans and this represents a return to a normal level of impairments. The unusual loan reversions in H121 were large enough to make provisioning expenses negligible in H121 (specifically, there was a net 0.1% of loans). These reversions, which were an industry-wide phenomenon, occurred because asset quality turned out to be much better than initially feared (and provisioned) by the banks in FY20 during the beginning of the pandemic.

STB’s impairments were centred in vehicle finance (annualised 8.0% of loans) and retail finance (1.4% of loans). We note that the vehicle finance provisioning was above average and reflects the fact that the business was paused and restarted; management believes that the cruising speed impairments level will be closer to 5.5% of loans.

STB completed the sale of DMS to Intrum UK Finance in May 2022 after announcing the deal in April 2022 (see our note from April 2022). This resulted in a pre-tax capital gain of £8.1m, although the company expects there to be some winding down costs relating to the sale in second half of FY22. STB received £81.9m for a loan book of £71.8m (2.6% of the loan book). Direct and indirect costs relating to the sale were £2m.

STB also completed in May the acquisition of AppToPay (announced in November 2021, see our note from November 2021) for £1m. AppToPay will provide the proprietary technology platform to allow STB through its Retail Finance business to enter the regulated buy now, pay later (BNPL) market.

STB reported an operating profit before impairments on its continuing business of £34.3m, +22% yoy. This was driven by balance sheet expansion and resilient margins. The cost to income dropped from 60% a year ago to 57% (underlying was 55.7% due to a one-off charge in H122 relating to corporate activities), as operating expenses rose by 8% while operating income grew 14%.

The normalisation of impairments resulted in a 42% decline year-on-year in PBT on a continuing basis to £17.1m. The EPS of the continuing operations fell 48% to 67p in H122. This EPS excludes the operations that have been sold and exited – DMS, consumer mortgages and asset finance.

Our underlying EPS only removes the actual capital gain on DMS sale (but keeps the operating contribution). On this basis the underlying EPS fell 52% to 67p (by coincidence the same as the continuing operations EPS).

Reported EPS was 102.4p, down 27% y-o-y and boosted by DMS capital gain. The normalised ROE was 8.3% for H122 and the reported ROE was 12.5%.

The CET1 ratio was 14.0%, helped by the sale of DMS; the balance sheet remains well capitalised.

We have made changes to our loan growth forecasts, but we still expect double-digit growth for FY22 and FY23. We have adjusted for the sale of DMS, reduced growth in real estate finance and increased our forecasts for the other three core segments.

The net impact of our changes is a reduction in loan growth by 1% and 4% for FY22e and FY23e. Our current forecasts are 16% and 13% y-o-y growth in total loans for FY22e and FY23e. If we exclude DMS in the year-on-year comparison, the loan balance growth would be 20% in FY22e.

The sale of DMS is largely earnings neutral in FY22 and FY23, but resulted in a reduction in revenue and costs. The more defensive loan mix in the real estate finance division and the lower margins in retail finance also contributed to a reduction in net interest forecasts. We are now forecasting 3% and 13% increases in net interest income on a continuing business (ex-DMS) for FY22e and FY23e. We forecast the net interest margin as a percentage of average loans to decline from 6.2% in FY21 to 5.7% in FY22 and remain at this level in FY23.

Most of the STB’s lending (outside real estate finance) is fixed rate and therefore less interest rate sensitive. However, we would expect STB to pass a good portion of the increase in the funding rate to borrowers.

After the investments made in FY21, which caused the cost to income ratio to increase to 63%, we forecast the cost to income ratio to decline to 58% in FY22e (it was 57% at H122) and then to 52.5% in FY23. This is similar to our previous forecasts of 58% and 53% for FY22e and FY23e. Management maintains its medium-term goal of a cost to income ratio of below 55%.

We have kept the level of impairments about the same (1.3% of loans in FY22e and FY23e) with an increase in our vehicle loan impairments assumption being offset by lower retail finance forecasts. STB’s relatively short loan duration and proven management nimbleness mean that we expect the bank to make changes relatively quickly should lending conditions change. The key risk to earnings is in vehicle loans and retail finance, where the lending risk (and margins) is concentrated.

All of this adds up to 6% and 12% reductions in the normalised EPS for FY22e and FY23e. This represents a 38% EPS decline on FY21 (earnings boosted by COVID-19 related loan reversals) followed by a 29% increase in FY23e. We have stripped from our figures the capital gain from the sale of DMS (£8.1m before tax, £6m after tax). We are forecasting normalised ROEs of 8.9% and 11.6% for FY22e and FY23e. The forecast reported ROE is 10.9% for FY22e.

We expect STB’s balance sheet to remain well capitalised. We estimate a CET1 ratio of 13.7% and 12.9% for FY22e and FY23e; management’s target is to keep the ratio above 12%.

We continue to value STB on an NAV approach using the (ROE-g)/(COE-g) formula. We have reduced our assumptions of a sustainable ROE from 13.5% to 13.0% to consider the likely more challenging macro environment in the next couple of years. We maintain our assumptions of a 10% COE and a 2% increase in long-term earnings. The FV of 2,407p is equivalent to a P/BV multiple of 1.38x, compared to the trading FY22e P/BV of 0.64x, suggesting significant upside in our FV.

STB is still trading below its book value despite its track record of value-creating ROEs (ie above its 10% COE) and this in part reflects the market heavily penalising cyclical stocks like financials at a time of heightened economic concerns and uncertainty. We do not envisage any losses at STB that could possibly eat into its book value and capital base.

Exhibit 6 compares STB’s market multiples with some of its peers. STB is trading at an 11% premium in terms of FY22e P/E to its peers (7.2x vs 6.5x); we remove Metrobank from the average because it is loss making). However, we feel the size of this premium is almost inconsequential as the whole sector is trading at very depressed ratings. STB’s dividend yield is 42% higher than its peers. Its FY22e ROE is 24% below its peers (8.9% vs 11.8%) but it is trading at a wider FY21 P/BV discount of 32%, 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 FY21 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.