STB’s Q318 trading update was upbeat. There are signs that the repositioning strategy is working, trading conditions are robust and it is on track to deliver guided earnings. The Tier 2 capital issue during the period added 268bp to capital, further positioning STB for future growth. Our estimates are unchanged (EPS growth 32% FY18). The shares now trade at PNAV of 1.2x, which compares favourably with our forecast ROTE.
STB indicates that Q3 trading was strong and it is comfortable with full-year guidance, despite economic and Brexit concerns. We expect earnings and loans to grow by 32% and 28% in 2018, respectively. Repositioning has left STB with a lower risk book, focused on areas where the risk-reward pricing is currently better. STB notes that investments it made in collections in 2017 are having a positive impact on results this year.
The company is ready to increase its risk appetite when macro-political concerns decline and pricing is appropriate. STB has both operational and balance sheet headroom; the latter recently boosted by a Tier 2 level capital issue. Key drivers of our estimated loan growth are commercial finance and commercial real estate, but the emphasis may shift as the bank has shown a willingness to adapt to changing circumstances.
In Q318, STB raised £50m in fixed rate callable 10-year subordinated debt at 6.75%. While this has no impact on our CET1 year-end forecast of 13.2%, it adds 268bp of Tier 2 capital at a reasonable price. This takes our total capital ratio forecast to 15.9% by December 2018. This, combined with STB’s internal capital generation, gives management flexibility to react positively should market conditions improve.
STB shares are down 21.5% ytd and trading at an eye-catching 1.2x PNAV. This seems an undemanding valuation, given our ROTE forecasts of 12.7% this year, followed by 15.9% and 18.0% in 2019 and 2020, respectively. We believe that the market is still not giving STB credit for success in moving to a lower risk profile and focusing on profit margins across the various products. We feel that STB retains strong growth potential, while also showing a pragmatic and nimble approach to lending strategy. The update suggests it is on track to meet our expectations.