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FTSE 350: Recovery buoys financial services

Economic recovery, combined with the ongoing reluctance of big banks to lend, should buoy many financial services companies in 2015
January 29, 2015

The diversity of the financial services sector can make identifying sector-wide drivers somewhat misleading. But economic recovery, combined with the ongoing reluctance of the big banks to lend, looks set to buoy many - although not all - of the sector's constituents during 2015.

Take Paragon (PAG). It's largely a buy-to-let mortgage lender, and with the housing market booming - making home ownership unaffordable for many - demand for rented accommodation is robust. That's driving strong demand for Paragon's services from private landlords: the lender's completions were up 83 per cent in the year to end-September. Mainstream banks continue to neglect buy-to-let lending, too. With the housing supply-demand imbalance unlikely to change any time soon - and deflationary pressures keeping interest rates low - we expect Paragon's prospects to remain bright.

Close Brothers (CBG) and sub-prime lender Provident Financial (PFG) are also benefiting from a stronger economy and picky mainstream banking sector. Strong demand in Close's core motor finance, property and SME lending business helped drive group profit up by a fifth in the year to end-July, and broker Numis Securities expects group earnings to rise 13 per cent in the current year. Meanwhile, Provident Financial's Vanquis credit card operation - its biggest business - has continued to bound ahead. Its Satsuma online instalment credit offering should do well in 2015, too, as tough new Financial Conduct Authority (FCA) rules force the closure of possibly hundreds of small payday loan competitors.

Eastern Europe-focused doorstep lender International Personal Finance (IPF) is benefiting from strong growth in its core Polish market, as well as in Hungary and Mexico, and there are plans to move into Spain. That said, regulatory pressures - credit caps in various forms are being considered throughout eastern Europe - could hit trading. Currency movements can be an issue, too: the half-year figures were dented by a strong pound.

Given rand weakness, currency is a perennial worry for Investec (INVP), the South African asset manager and bank. But that shouldn't detract from the group's robust underlying performance. Indeed, rand profit at the South African unit - which generates over two-thirds of group profits - should continue growing strongly, given Investec's exposure to South Africa's growing middle class.

One weak sub-sector was interdealer broking: both ICAP (IAP) and Tullett Prebon (TLPR) were hit as low levels of market volatility combined with bank deleveraging in a tougher regulatory environment to reduce trading volumes. Low market volatility has historically been a problem for spread betting specialist IG Group (IGG), too. The bigger news this year, however, is that the Swiss National Bank's decision to abandon its cap on the Swiss franc has saddled IG with £30m in losses. That will hurt full-year earnings and could even lead to greater regulatory scrutiny.

Company nameShare price (p)Market value (£m)PE ratioDividend yield (%)1-year performance (%)Last IC View
3i4424,2968.14.412.0Buy, 409p, 14 Nov 2014
Allied Minds420896NA0.0NANone
Close Brothers1,5152,26414.63.212.1Buy, 1,424p, 23 Sep 2014
ICAP4592,97716.94.85.6Sell, 397p, 19 Nov 2014
IG Group7382,70017.84.217.0Buy, 612p, 22 Jul 2014
Intermediate Capital4681,80311.94.69.4Buy, 431p, 18 Nov 2014
International Personal Finance42398011.32.3-13.2Buy, 573p, 13 Jul 2014
Investec5513,38114.33.527.3Buy, 591p, 21 Nov 2014
IP Group2181,0479.50.025.2Hold, 217p, 1 Sep 2104
London Stock Exchange2,3418,12219.91.239.6Hold, 2,054p, 14 Nov 2014
Paragon Group of Companies4121,26112.92.215.6Buy, 393p, 15 Nov 2014
Provident Financial2,5203,69020.53.550.5Buy, 2,112p, 20 Aug 2014
Tullett Prebon32178210.85.3-16.2Hold, 527p, 30 Jul 2014

Favourites

Strong fundamentals look set to continue supporting robust demand for buy-to-let mortgages, leaving Paragon in an especially sweet spot. Improving credit demand should buoy Close Brothers, too. Neither's shares are demandingly rated: Paragon's trade on just 11 times earnings forecasts for 2015, while Close's are rated on 13 times, compared with a sector average of 17 times.

Outsiders

Low levels of market volatility could continue to depress trading for the interdealer brokers. Sentiment towards ICAP in particular could suffer in 2015, given ongoing investigations into its role in various rate-rigging scandals: Libor in Europe and the ISDAfix benchmark in the US.