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Get growth on the cheap from OneSavings Bank

The challenger bank's shares are trading at a significant discount despite having good income and growth prospects
November 10, 2016

OneSavings Bank (OSB) has had to deal with the triple whammy of stamp duty changes for buy-to-let landlords, referendum-induced uncertainty and a cut in the Bank of England base rate. While the challenger bank's shares have recovered solidly since the end of June, the cumulative effect of these shocks has meant the share price is still down more than a quarter year on year. However, the slump has yet to be justified by a slowdown in demand for the bank's loans. In fact, last week the bank reported £510m in organic loan applications in the three months to the end of September. We reckon concerns about the bank's growth prospects are overdone, with risk already well priced in. With the shares now trading at a large discount to their historical average, we recommend buying.

IC TIP: Buy at 279p
Tip style
Growth
Risk rating
High
Timescale
Long Term
Bull points
  • Shares at a discount to historical average
  • Superior returns on equity
  • Strong loan book growth
  • Growing dividend yield
Bear points
  • Buy-to-let risk
  • Potential interest rate pressure

OneSavings Bank lends primarily to small- and medium-sized businesses (SMEs), buy-to-let landlords and residential homeowners. Lending to the buy-to-let and SME sectors has delivered the strongest growth in net interest income (NII) so far this year. During the first six months of the year, NII for this segment was up by almost half to £61m year on year. This was because gross loans to these customers increased by more than a third to £3.5bn during this period. The bank increased its organic lending by a quarter to £800m during the first six months, in particular in buy-to-let through the Kent Reliance and InterBay brands. With strong demand continuing during the third quarter, growth in net loans and advances has reached £466m over nine months, taking the total to £5.6bn.

 

 

It is still early days in terms of understanding the long-term impact of the increased stamp duty rate for buy-to-let landlords. The reduction in mortgage interest rate relief also looms on the horizon for some of these borrowers: mortgage interest tax relief will be gradually cut back to 20 per cent from April 2017 until 2020. OneSavings Bank chief executive Andy Golding says the group typically lends to professional landlords and these landlords should have the ability to insulate themselves against the changes by setting up limited companies - which are exempt from the restrictions - through which to let their properties. What's more, growth prospects should be helped by the fact the bank only serves 1 per cent of the market and, according to broker Shore Capital, is writing about 4 per cent of new flow, including 8-10 per cent from professional landlords.

The Bank of England's reduction in the base rate to 0.25 per cent has put pressure on banks' net interest margins. OneSavings Bank's net interest margin has so far held up and is expected to remain at the level set at the half-year stage of 3.07 per cent for the full year. This should be assisted by the reduction of its standard variable rate (SVR) by 25 basis points in September and the hedging of liabilities that are priced at a fixed interest rate. This should ensure the bank continues making superior returns on equity compared with its peers. The banking corporate tax surcharge decreased returns on equity slightly to 29 per cent during the first half, from 31 per cent in the previous year. However, this compares with Secure Trust (STB) at 20.4 per cent, Aldermore (ALD) at 18 per cent and a return on tangible equity of 21.2 per cent from Shawbrook (SHAW) during the same period.

There could be good news for banks if inflation rises markedly next year, as the Bank of England expects. The Bank of England has forecast that inflation will hit 2.7 per cent in 2017, up from 1 per cent at present. And if inflation surprises to the upside in 2017, a sharply steeper gilt curve could improve the earnings per share outlook for banks. Banks typically show the highest outperformance correlation to rising yields.

ONESAVINGS BANK (OSB)

ORD PRICE:279pMARKET VALUE:£678m
TOUCH:278-279p12-MONTH HIGH:413pLOW: 173p
FORECAST DIVIDEND YIELD:3.9%FORECAST PE RATIO:6
NET ASSET VALUE:155pLEVERAGE:16.9

Year to 31 DecTurnover (£m)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
2013643013.4nil
20141187024.44.1
201516110634.78.7
2016*20013340.110
2017*22514443.911
% change+12+9+9+10

Normal market size: 1,000

Matched bargain trading

Beta: 0.21

*Shore Capital forecasts, adjusted EPS and PTP figures