1H’23: steering through the interest rate wave

ABG’s income has been driven by the way in which it has managed its franchise – specifically, building a relationship bank with less price-sensitive deposits. Spreads have widened in a rising rate environment, despite ABG offering competitive rates to its relationship customers, and group operating income increased by 51% on 1H’22. Margins may have peaked now. We previously expressed the view that, if the base rate were sustained at 4%, or higher, there could be marketwide credit issues. The very early signs of this are now evident. However, ABG’s conservative approach, with its low LTVs, good-quality security (primarily residential real estate) and stress testing curtailing lending, means it is positioned well.

• New franchise growth: ACABL profits grew from £2.9m in 1H’22 to £4.0m, with modest loan growth. RAF lending increased from £103m to £157m, with credit quality better than expected. AA leased asset and HP loans grew from £129m to £259m, including £42m acquired at a discount.
• Balance sheet strength: 1H’23 loans and leases were up 7%, to £2.3bn (end- 2022: £2.0bn), and deposits were £3.3bn (end-2022 £3.1bn). Surplus liquidity is deployed primarily in accounts with the Bank of England, and not in mis-matched- duration government bonds. The total capital ratio was 14.5% (end-2022: 14.0%).
• Valuation: Our multiple approaches see a broad range of valuations: £11.58 DDM, £27.43 SOTP and £23.99 GGM. The average is £21.00 (£20.73), reflecting a higher capital base, raising the GGM and earnings mix changes. Trading at 71% of NAV is anomalous, in our view, with above the cost of capital returns and given ABG’s growth potential.
• Risks: Margins may have peaked now, with the trend, and level, of interest rates a key driver to earnings. Credit is a risk, but ABG is conservative in lending, taking good security. Short-duration assets and a conservative culture mean there is no OSB read-across. Other risks: 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 below book value is an anomaly, in our view.