Arbuthnot Banking Group plc (LON:ARBB) is the topic of conversation when Hardman & Co’s Analyst Mark Thomas caught up with DirectorsTalk for an exclusive interview.
Q1: You called your recent note ‘2023: delivering strategy with strong profit growth’, can you give a short summary of your key findings?
A1: The saying goes, the proof of the pudding is in the eating. Arbuthnot Banking Group’s 2023 results proved that the strategic positioning of the group, as a relationship bank, has created enormous value.
Key highlights were i) PBT £47.1m (2022: £20.0m), ii) operating income £178.9m (2022: £137.4m), iii) average net margin 5.7% (2022: 5.1%), iv) EPS +103% to 222.8p, v) total dividend for the year of 46p (2022: 42p), vi) net assets of £252.4m (2022: £212.0m), NAV per share of 1,547p (2022: 1,411p), vii) CET1 ratio of 13.0% (2022: 11.6%), and total capital ratio of 15.2% (2022: 14.0%).
Customer deposits grew 21% to £3.8bn, loans by 6% to £2.3bn and FUM by 29% to £1.71bn.
Q2: If I read your note correctly, you are saying that it is management choices that are optimising the core relationship banking franchise, and so profit. What have they been doing there?
A2: In our previous notes, we have emphasised how the company has built a relationship bank, which, in a period of rising interest rates, can offer competitive deposit products that are profitable to the bank. This suite has been the focus of marketing, given the interest rate outlook and its capital efficiency.
It is encouraging that growth in the bank’s client base has continued, from the existing franchise as well as from new segments, with an impressive deposit growth of 21% in the year. The average cost of funds last year was 2.43%, with a year-end run rate of 3.17%, well below market average rates.
As the group places most of its surplus liquidity with the Bank of England, this average cost of funds is not only below peers but also well below the level of income it earns, making deposit-gathering a very low-risk and profitable business in its own right.
Q3: So, can you tell us first about the growth in the SME franchises?
A3: The group, in recent years, has invested in a number of specialist finance businesses, which are now reporting the strong growth inherent in the ambitious “Future State 2” plans.
These include: i) RAF finished the period with a loan book of £176m, compared with £157m at the half-year, equating to a 33% increase since 31 December 2022; ii) Asset Alliance had Assets Available for Lease of £276m at 30 September 2023, compared with £259m at 30 June 2023 and £172m at 31 December 2022, and iii) despite the slow PE market activity, a major source of new business, Arbuthnot Commercial Asset Based Lending, maintained its loan book over the quarter to finish at £244m.
Q4: So, it positioned itself very well for a rising rate environment. What is it doing to cushion the effects if rates start to fall?
A4: Firstly, it has repositioned the balance sheet with an extension in the duration of its short-term securities. At the year-end, it has £220m re-pricing in three to six months and £286m in six months to a year. These are up from just £13m and £86m at the end of 2022, respectively, and it means assets will reprice slower if rates fall. Additionally, it has increased debt securities as percentage of liquid assets from immediately re-pricing Bank of England deposits.
The group continues to be very prudently managed – our note details why there is none of the Silicon Valley type of risk here. In some ways, I see those actions as a tactical response to the outlook.
Perhaps, more important is the strategic Future State vision, which has a far greater proportion of fixed rate SME finance than the existing book. Again, this will see assets reprice more slowly in a falling rate environment.
The final point I’d make is that expectations for a rate decline are currently very gentle (much longer than when rates rose), which gives time for the Bank to manage this risk.
Q5: You mentioned the Future State vision and the growth of SME financing franchises. What progress was made there in 2023?
A5: Renaissance Asset Finance made a profit of £1.6m, up from £0.2m, with accelerating loan book growth of 49% and this is after £5.6m (2022 £1.5m) paid to the bank for internal funding. Arbuthnot Commercial Asset Backed Lending made £8.5m, against £5.2m, with higher client volume generating increased interest charges and service fees. Asset Alliance Group saw 73% new lending growth.
Q5: What about credit quality?
A5: The group’s conservatism in tightening lending criteria in 2H’22 and taking high-quality security has paid off with impairments remaining extremely low. There are no early indicators of problems. There has been a small rise in some accounts in arrears, but we understand this includes a couple of situations where a refinancing has been delayed and so it is a technical issue rather than a credit one. We continue to watch it like a hawk and have built in conservative assumptions into our forecasts, but the credit quality was a real positive in these results.
Q5: Any other notes of caution?
A5: Arbuthnot Banking Group is experiencing net interest margins that are higher than it expected over the longer term, as the repricing of deposits generally has a delay of up to 12 months as time deposits reach maturity. Also, the group is yet to see the full impact of the inflationary pressures on its cost base.
As always, there is macroeconomic uncertainty, and the political environment creates its own uncertainties too. Credit deterioration is an obvious risk, but, as I mentioned, the group has been conservative in new lending criteria and taking security, which should reduce both the probability of default and any loss in the event of default.
