To be resilient in an economic storm, a bank needs three things – low risk assets, strong capital and surplus deposits. Arbuthnot Banking Group Plc (LON:ARBB) has all three. At end-2019, 55% of loans were in the private bank (significantly secured on sub-60% LTV residential properties) or the acquired mortgage book. Just 1.5% of the commercial loan book was on 80%+ LTV. The equity-to-assets ratio was 8% and total capital ratio, 17.3%. The regulators have reduced capital buffers – we estimate ABG has ca.£60m of surplus capital. There is surplus liquidity: deposits £2.1bn, loans £1.6bn. ABG announced an increased dividend but withdrew it following PRA market guidance.
- 2019 results: Underlying PBT was £5.8m vs. £4.4m (re-stated). Income was up 7%. Impairments saw a net release in 2H. The FY charge was £867k vs. £2.7m. Despite heavy investment, costs rose 8%, only 1% ahead of income. Loans were up 31% to £1.6bn. Deposits increased 22% to £2.1bn. Assets under management rose 12%.
- Outlook: There are too many moving parts to rely on single projections. We have introduced a range of scenarios. Our central case is zero profit in 2020, reflecting margin pressure following base rate cuts and COVID-related losses. The upside scenario profit is £6m. The extended economic-downturn scenario is a £15m loss.
- Valuation: Our forecast scenarios, and multiple valuation approaches, see a broad range of implied valuations. Our base case range is 871p to 1,912p, our upside scenario 1,183p to 2,377p, and our downside 782p to 1,424p. The share price is 54% of the 2019 NAV (1,364p), implying value destruction to perpetuity of £97m.
- Risks: As with any bank, the key risk is credit. ABG’s existing business should see below-market volatility, and so the main risk lies in new lending. We believe management is cognizant of the risk and, historically, has been very conservative. Other risks include reputation, regulation and compliance.
- Investment summary: ABG offers strong-franchise and continuing-business (normalised) profit growth. Its balance sheet strength gives it a number of wide-ranging options to develop organic and inorganic opportunities. The latter are likely to increase in uncertain times. Management has been innovative, but also very conservative, in managing risk. Having a profitable, well-funded, well-capitalised and strongly growing bank priced at half book value is an anomaly.