Hardman and Co Financial Stocks and Investments Funds Analyst Mark Thomas caught up with DirectorsTalk to discuss Arbuthnot Banking Group Plc (LON:ARBB)
Q1: Now Mark we’re talking about Arbuthnot today, can you tell me what I’m buying when I buy into them?
A1: Arbuthnot Banking Group is a business that’s in transition, its management has over the years built a number of businesses, some of which have been very successful and then it’s actually been selling some. So most recently it’s been selling most of its stake in Secure Trust Bank which is a retail bank meaning that Arbuthnot is very cash rich so the first thing that you’re buying is £150 million of surplus capital. It also has a private bank and that private bank is called Arbuthnot Latham and it also retains a small stake in Secure Trust that’s worth about £70 million. Looking forward we can’t be certain exactly how it will deploy the proceeds and in particular that £150 million of surplus capital, it is most likely to be in a mix of loan growth, investing in new teams, buying loan portfolio, possibly buying some businesses and we believe returning some capital to shareholders. So you’ve actually got a mix of things in the future which you’ll be buying an existing private bank and growth which will be funded by this capital. As a bank it’s well capitalised, it’s well funded and it’s growing strongly.
Q2: So why should I be buying into something that I don’t know exactly what I’ll be getting?
A2: Well the first thing is that the market capitalisation of Arbuthnot Banking Group is below its net assets so you’re actually buying it cheaply today, you’re not paying anything for the growth or the value that the business may add by deploying its surplus capital. The upside to that is very big, by way of illustration we believe that if they deployed all the surplus capital in lending for example the value of the group would be twice its current market cap. It is worth remembering that the Chairman owns 55% of the shares and his interests are very much aligned to yours but fundamentally you’re buying a business which is cheap today with very significant growth upside.
Q3: Can you describe its private bank which is now the core business?
A3: Yes, Arbuthnot Latham is an on-shore private bank which is driven by its balance sheet, so lending and deposits, and that’s actually quite important because it’s not involved in tax structuring or putting money off-shore and as a consequence it doesn’t face some of those big regulatory risks that you’ve seen with say HSBC and its Swiss private bank. Now Arbuthnot Latham, they started to really invest in new teams, new offices about 2-3 years ago and are starting to see the payback of that now in terms of loan and deposit growth, we expect that to continue and indeed to accelerate. The management has built an infrastructure in Arbuthnot Latham for a much bigger business than is there today and while this investment is hitting current returns we expect the growth and the extra lending and deposit will quickly generate good returns and for the profitability of the bank to be over 20% by 2018. So you’ve got a bank that is well capitalised, it’s well funded, it has relatively low regulatory risk because of the nature of its business and we’re expecting strong growth.
Q4: Do you think then if they acquired something, what do you think that would be?
A4: Yes, Arbuthnot have actually been quite active in a range of areas, we would definitely expect them to be acquirers of teams of people and portfolios of loans, it has bought portfolios of loans before, they typically are from sellers where the loans were not a core part of their business so they were a peripheral and in many cases a sub-scale business so Arbuthnot could buy them cheaply so there’s a value added from buying loans. Its acquisitions of businesses in the past have also been very selective, typically it would find a seller which had a good franchise but which was selling cheaply, now why would the seller be selling cheaply, often it’ll be because they may have some difficulty in funding their business, banks have access to funding that non-banks don’t have, it could be a management issue but to give a very simple example, when they bought Everyday Loans for £1 the strong balance sheet of Arbuthnot meant it could fund it better and sell it at a profit of over £100 million just a few years later. The areas which could see difficulty and therefore maybe where you could get a good franchise cheaply, potentially something like peer to peer lending, if a peer to peer lender was to fail we could see Arbuthnot buying with its loan portfolio or perhaps its loan origination capacity, it may not buy the failing business itself but it would cherry pick the interesting bits. So in summary, we think they’ll be very careful and they will most likely buy something to which manage Arbuthnot’s management, its capital strength and its strong funding can add real value.
Q5: When do you think Arbuthnot Banking Group Plc will return capital?
A5: When we look at the opportunities deploying the capital in lending or acquisitions we think would be the preferred option of management, having said that £150 million is a large amount of capital to use. We think that they will actually deploy some, they will turn a little bit in the near term so we’ve £25 million in the next 12 months or so and then we’ve got a further £50 million in 2019. They’re likely to do it by way of special dividend, historically when they’ve made a gain or there’s been a special event such as an anniversary, that they’ve returned capital by way of special dividend and when you look at the liquidity of the shares that seems quite a sensible way to do it. In summary, a little bit now to deploy most of it over the course of the next 2-3 years and then a further special dividend probably in early 2019.
