Secure Trust Bank’s (STB’s) pre-close trading update was encouraging, indicating it expects to deliver results in line with management’s and the market’s expectations. The bank has proposed a stop on new mortgage origination, unhappy with current price pressure and loan to value metrics, but does not expect this to have a material impact on 2018 and 2019 numbers. The bank sees itself entering 2019 with positive business momentum and robust capital and is well placed to continue its selected growth strategy despite the current political uncertainty.
At a time when the market is wary of negative trading updates, we see STB’s statement as reassuring and the lending prudence well suited to the current environment. The bank feels vindicated in its earlier decision to reduce risk in the loan book. Profitability has been supported by this move through improved credit quality.
Having previously shown some concern over contracting mortgage-lending margins and rising loan to value metrics in the market, management has announced a proposed stop on writing new mortgage business until conditions improve, potentially when the regulatory environment becomes more level from 2020. This decision is not expected to affect 2018/19 earnings materially. Otherwise STB’s loan momentum remains strong: loans exceeded £2bn at the end of 2018 (versus £1.6bn 2017), similar to our forecast. The growth is driven by retail finance, motor finance (where it has migrated from sub-prime to near-prime, a larger target market) and SME lending (mostly invoice financing).
STB’s shares are down 24.8% in the last three months and are now trading 9% below book value. This appears to discount a poor outcome with an ROE/COE model requiring an ROE of under 10% to match the current share price. We expect the bank to deliver an ROE of 11.1% in 2018, 14.0% this year and 15.6% in 2020. These are value-creating ROEs; as such, the bank is expected to trade at comfortably above its book value. Our DDM-based fair value of 2,443p suggests a P/BV of 1.8x. STB’s 2018e P/E of 7.6x does not look demanding given our EPS growth forecasts of 34% and 42% for 2019 and 2020.