Ghosts of City past, present and future

Change is a permanent feature of finance. Right now, the City is trying to work out whether its post-EU status will resemble Singapore-on-Thames, a green finance Mecca, or a light-touch playground for governance-agnostic corporates. But one aspect of the UK’s long legacy as a finance hub is that myriad institutions, from the brass plaque traditional to the beanbag-lounging cutting edge, can both co-exist and even compete.

This was on full display on Thursday, with the publication of three sets of full-year results for three very different financiers.

Founded in 1833, Arbuthnot Banking Group (ARBB) is resolutely old school. In the foreword to its written history, penned by the then Mayor of London Boris Johnson, the lender is celebrated for its role in financing “everything from coffee plantations in Ceylon to gold mining in South Africa to banana growers in Jamaica” in the early nineteenth century. Co-founder Alfred Latham’s ownership of slaves passes without mention.

The passage, proudly displayed on Arbuthnot’s website, sits in stark contrast to most modern banks’ current efforts to address racial injustice. But then Arbuthnot doesn’t seem to pay much heed to contemporary City optics, as notes to its 2020 accounts show.

This wasn’t an election year, so the company only made a £10,000 political donation to the Conservative party. In 2019 it could afford £77,000, or 1.2 per cent of net income, which was justified “in view of the significant adverse impact that a Labour government would have had” on the group and its clients.

Plenty of business leaders may have felt the same way, though few would ever consider trying to publicly tip the scales of a democratic vote. Five institutional investors cast their ballots against an ultimately successful resolution to make political payments at last summer’s AGM. Nine months on, Arbuthnot’s board insists such tributes are necessary “in light of prevailing political circumstances over the next few years”.

One wonders if shareholders might be better served if management focused on the things it can control, like capital allocation. Though customer deposits jumped 13 per cent to £2.37bn in a year where banks’ cost of funding fell, the loan book contracted and investments were largely confined to the acquisition of truck leasing business Asset Reliance and a new customer relationship management system.

Chief executive Sir Henry Angest – one of three knighted directors – saw his emoluments hold steady at £1.3m in the pandemic year. One might see that as only fair, given he also serves as chairman, though the lack of separation between the roles still contravenes that all-too-woke manual, the UK Corporate Governance Code.

Until its flotation in 2016, Angest also served as chairman of former Arbuthnot subsidiary Secure Trust Bank (STB). Arbuthnot’s stake in STB has now slipped below 10 per cent, just as the commercial lender has emerged as a far more enticing shareholder proposition.

Last year was, naturally, a tough one for the Solihull-headquartered group. But to chief executive David McCreadie, who joined 12 weeks ago, the market under-appreciated the fact that more than two-thirds of STB’s lending is asset-backed. Its shares continue to climb.

While new lending was pared back 27 per cent to £1.03bn in 2020, the group sees plenty of room to deploy capital in niche areas such as invoice financing. Unlike the recently-collapsed Greensill, which built a fated niche in ‘future accounts receivable’ financing, STB extends “low volume, large ticket” supply chain finance to household names with security.

This type of repeatable and profitable work has given McCreadie confidence to set a minimum net interest margin target of 6 per cent, which sounds like a platform for future growth.

But is the future of finance tech-enabled, decentralised and actually much brighter? Or forever loss-making? As a peer-to-peer lender, Funding Circle (FCH) may not be a perfect test of these questions, though unlike the so-called neobanks Revolut and Monzo, it has a business plan that includes both lending and deposit-taking activities.

Its differentiating factor – a platform that processes loans at faster speeds than STB or Arbuthnot could ever imagine – is, alas, still chewing through cash. Greensill’s downfall has also cast a pall over any fintech’s claims to ‘machine learning’ supremacy, despite chief executive Samir Desai’s assurance that the technology will help Funding Circle “solve more small business funding problems” in the coming year.

Desai will need to do that as the kicker from government-backed lending programmes dissipates. Adjusted Ebitda is already expected to fade as 2021 progresses.

A more reliable constant of City lending activity, residential mortgages, has emerged from 2020 without major incident. A mix of stamp duty relief, furlough scheme can-kicking, lender clemency and new demand kept the housing market lights on, softening fears of a major downward revision in asset prices and ensuring monthly payments kept flowing.

Against this backdrop, investors in buy-to-rent specialist OSB (OSB) – formerly OneSavings Bank – have been told underlying earnings per share will dip just 5 per cent to 61.4p when full-year figures are finally unveiled on 8 April. Loan book growth, in-line credit losses, and a sector-leading cost-to-income ratio of 27 per cent will also feature.

The one fly in the ointment, and which caused the delay in the figures’ publication on 17 March, was the discovery of “potential fraudulent activity” by one of the third parties to which OSB extends funding. The loan in question, which is secured against lease receivables and hard assets, had an outstanding receivable of £28.6m at the end of December.

This may now require a full impairment, pending the result of an investigation by accountants Smith & Williamson. While unwelcome, OSB’s forecast return on equity of 16 per cent this year remains very strong for the sector, making the shares the standout buy.

STB’s higher relative cost profile means a medium-term target for returns of 14 to 16 per cent could prove tough, though for reasons of both governance and strategic direction, we see less reason for a market discount to net assets than Arbuthnot. Funding Circle remains a high-risk proposition, and a dilutive equity raise in the next couple of years cannot be ruled out. But its prospects of attracting fresh capital have probably edged up. Hold.

Last IC Views: Hold, 805p, 15 Jul 2020 (ARBB), Hold, 830p, 7 May 2020 (STB), Sell, 56p, 24 Sep 2020 (FCH), Hold, 306p, 27 Aug 2020 (OSB)