SIF Folio: Secure Trust Bank May Deserve A Higher Rating

12th May '21 by Roland Head

9 comments 2802 reads

It’s been a while since I’ve owned a banking stock in SIF. But I feel that there are some attractive valuations in this sector at the moment, so I’m happy to be able to have a look at a lesser-known banking stock this week.

Secure Trust Bank (LON:STB) is a recent addition to the results of my buying screen. This £220m West Midlands-based bank is not a company that I’ve ever owned or researched in detail, but my initial impressions are favourable.

Secure Trust uses a traditional savings and loan banking model. Savings are collected from retail customers and loaned to retail and business clients through a mix of asset-backed, property and vehicle loans. The bank has 1.5m customers, £2bn in customer deposits and £2.4bn in loans.

Until 2016, Secure Trust was controlled by AIM-listed private bank Arbuthnot Banking. However, Arbuthnot sold a 33% stake in STB in 2016, ceding control of the business. Arbuthnot has continued to sell down its stake since that time and now controls just 4.4% of STB stock.

Why I’m interested

I’m looking at Secure Trust Bank for the SIF folio because it passes all my screening tests, and does not duplicate any of the portfolio’s existing stocks. But I’m glad to have the opportunity to do this, because I believe that last year’s crash has left some of the UK’s smaller listed banks trading at attractive levels.

Recent years have seen specialised lending banks such as Paragon Banking, OneSavings Bank, Close Brothers (disclosure: I hold) and Secure Trust generating much higher returns on equity than the big FTSE 100 banks.

In this case, the Stockopedia data indicate that Secure Trust has generated an average return on equity of 9.2% since 2015, including 2020.

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In contrast, Lloyds has averaged just 5.2%. Barclays has achieved an average RoE of just 2.4%, despite (because of?) its legion of highly-paid investment bankers.

I suspect the smaller banks’ lack of PPI liabilities account for some of this differential. But I think that another reason for their outperformance is that these more specialised banks can lend money more profitably than their mainstream rivals.

We can get a feel for this by comparing the banks’ net interest margins. This banking metric compares the interest rates on funding…

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Indie

12th May '21

Hi Roland, v interesting. Any idea why it doesn't have a Bankruptcy Risk Z-score?

gus 1065

Hi Roland.

Thanks for this - always a good read. I don’t know Secure Trust Bank (LON:STB) , but as a general comment I’d observe that the lending spread charged by the banks is the price of credit to their customers. It has many components, one of which is an assessment of the risk of delinquency and default by the borrower. In a competitive lending market, the fact that their margin is 2 to 3x that of Lloyds suggests either that they’ve exploited a customer niche that the others can’t access or that they are happy to take on corporate customers at the riskier end of the credit spectrum. Fine when the economy is on a roll and the impact of Covid dislocation is being postponed by government grants and easy monetary policy but potentially more problematic in a downturn.

The likes of HBOS and Bradford & Bingley seemed to be shooting the lights out in the early noughties with the huge growth in their corporate lending book ..... until the music stopped and they went “bang!”.

Gus.

Looking at their website, I see that the AGM was 10am today.

Bouden54

I think it is more the former - niche areas of the lending market can charge higher rate but not necessarily with higher risk. Secure Trust bank have always been pretty conservative lenders and theirs impairment rates actually look a lot better than the big banks.

Roland Head

Hi Gus,

That's a fair point - a wider net interest margin does indicate (in theory at least) a higher degree of lending risk. However, in this case I think that the focus on more profitable niche areas explains much of the extra margin.

Looked at a different way, I suspect that if we stripped out the huge prime mortgage book from Lloyds Banking (LON:LLOY) accounts and looked at its motor finance and corporate loan books, we'd find a higher net interest margin on those riskier/more specialist products.

For example, £MOTOR offers Black Horse (Lloyds) finance to customers from 7.9% APR.

I think competitive mainstream mortgage lending must be the main factor holding back the big banks' interest margins. After all, when fixed mortgage rates for prime borrowers are well under 2%, how much margin can be left? Not a lot, I suspect, even with near-zero funding costs.

In my view, the mid single digit NIM generated from SME lending by smaller banks such as Secure Trust Bank (LON:STB) reflects their specialisation and does not solely imply excessive credit risk. That said, I think that Secure Trust's market includes some near-prime lending. Some of this could become sub-prime in a recession...

Certainly, I agree that in a downside scenario, credit performance could get much worse.

Even so, I think the comparison with HBOS and Bradford & Bingley in 2008 is a little harsh. As far as any of us can tell, banks do have much stronger balance sheets and lower leverage than 12 years ago. They should be able to absorb losses more easily. Time will tell, I guess.

Roland

Interestingly they just released a trading statement at 4.15pm. All seems to look OK at first glance with steady pick up in new lending.

Griffs

Isnt it the case that banks cant be allowed to go bankrupt ?

Silver Fox

14th May '21

I think the Stockopedia analytics don't work particularly well for Banks and that is one of the reasons why the Z-Score isn't populated for any of them

There are some good points in here, but remember that most bank failures are caused by liquidity issues.

Banks specialise in maturity transformation i.e. they borrow short and lend long. This in itself creates a natural margin as short term rates are lower than long term ones - even in today's weird interest rate world. If a bank runs into trouble, depositors can get their money out far quicker than a bank can call its loans.

A word of caution that I would sound here is that STB seems to have a high level of deposit funding. If there is a downturn post the phasing out of Covid reliefs then its lending book could suffer, potentially undermining its business model.

SIF Folio: Secure Trust Bank may deserve a higher rating

Why I’m interested

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Roland Head

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