Arbuthnot shares soar as customer deposits increase

It’s early days in the half-year reporting season, but the impact of rising interest rates on the broader financial sector is already apparent. Interim reported profits for Arbuthnot Banking (ARBB) leapt thanks to the widening of its net interest margin, the difference between what it pays and receives in interest payments. However, it expects the differential to narrow as there is an inherent lag in the repricing of deposits to current market levels.

It pays for banks to keep their depositors onside as management concedes that “the deposit market continues to remain extremely competitive, with many offers for term deposits of one year now well in excess of the base rate”. Nonetheless, Arbuthnot saw a 16 per cent increase in customer deposits year on year, although management noted that cheaper deposits will be replaced with those at higher rates going forward, thereby increasing the overall cost of funding.

It’s undoubtedly something of a balancing act: the cost of deposits averaged 1.9 per cent for the first six months of the year but is expected to peak at 2.9 per cent over time, assuming base rates remain unchanged for the next 12-18 months. Unfortunately, calling a top in the current interest cycle has become something of a fool’s errand.

Rising interest rates usually translate into increased credit risk. Arbuthnot notes that it has yet to see a “significant deterioration” in its loan book, although there are certainly signs of financial stress. It has tightened its credit criteria accordingly, while provisions for expected credit losses have more than doubled from the same period last year.

The figures were well received by the market and the bank still trades at a sizeable discount to NAV, yet consensus figures suggest that its return on tangible equity will deteriorate over the next couple of years. Hold.

Last IC view: Hold, 960p, 30 Mar 2023