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: Mark, you’ve called your recent note ‘2024 results, franchise growing through the noise’, could you give us a short summary of your key findings?
A1: The core of any successful business in the long term lies in offering clients and customers the products that they want so that they will give you more business and in turn you can attract more new customers.
Now, the 2024 results show how Arbuthnot Banking Group has achieved this with growth in specialist lending, it’s now £828 million, that’s 35% of loans, up from 21% in 2021. It grew deposit volumes by 10% and in the wealth management, the funds under management grew by 30%. 1,200 new banking clients were onboarded in 2024 alone.
The short-term profits reflect the fact that the group had optimised returns in the rising rate environment earlier. So, 2023 pre-tax profits were £47 million against £4.6 million in 2021 but then in 2024, it faced the predicted margin pressure and so profits fell with 2024 profits at £35 million.
Q2: Now, you said that profits fell. What drove that? Was it expected?
A2: Yes, it was expected, that’s the important thing.
In our April note in 2023 ‘Delivering strategy with strong profit growth’, we detailed how in 2023 Arbuthnot had saw the maximum, and I’ll repeat, the maximum benefit from how the group positioned itself for a rising rate environment.
In summary, it chose to have a structural sensitivity with more assets repricing than liabilities. It invested in relationship banking so it could raise significant deposits at below base rate and place them at the Bank of England, earning a positive spread and growing deposits at a time when they were profitable in their own right. It saw term deposits which were locked in for the duration of their term and only repriced up as they matured and not immediately on the change in base rate. Historically, it took them up to 18 months for its deposit books to fully reprice.
Now, it was well-flagged and hopefully well-known and understood by investors that the wind-down of this lag effect was the key driver to profits falling from their unsustainably high level in 2023.
Basically, in 2023, the group benefited from savings that had been locked in at lower rates and as these deposits reached maturity, as expected, they repriced at a higher level.
Q3: You highlighted that the franchise growth will drive long-term shareholder returns, what can you tell me about that?
A3: As I noted earlier, a core driver to long-term performance is giving customers what they want so that they give you more of their business and you attract more customers. Now, in 2024, this was seen across the group’s different businesses with, as I mentioned, 1,200 new banking clients onboarded, 48% of which were non-personal.
Looking in a bit more detail, the number of private clients grew by 9% in 2024 to more than 5,000 at the year-end, a significant outperformance against the market, which is believed to have seen a decline of 1% in the total number of accounts in the year.
A total of 210 wealth management clients were onboarded in 2024, that was a 51% increase on 2023. The Asset-Backed Specialist Lending division completed 22 new transactions, compared with 17 new transactions in 2023. The RAF and Asset Alliance Group customer numbers are not disclosed, but respectively saw 25% and 11% lending growth, which we believe is indicative of delivering products for which there is a strong demand.
The strong growth in deposits and wealth management that I mentioned earlier, 10% and 30%, speak for themselves.
Now, as we detailed in our note ‘The trading update, taking Arbuthnot to the next level’, which we published in October 2023, the group has invested heavily upfront to build an infrastructure to service a much larger pool of business. By way of example, it moved to larger premises in London. Now, the financial benefit of all this franchise growth has yet to be fully seen.
Q4: You’re forecasting a further modest profit dip in 2025, before seeing it grow again in 2026. What’s going to be driving that?
A4: First of all, I’d say forecasts at this stage need to be treated with a fair degree of caution.
The business is still sensitive to the level of, and changes in, and timing of changes in interest rates. Our forecasts are based off of further modest reduction in rates with more pressure that was seen in 2024 from deposit repricing finally coming through.
Management has not sat on its hands. Mitigating actions have included growing specialist lending, which is largely fixed rate, a switch from Bank of England deposits to securities and extending the duration of securities. Looking in aggregate of all the assets and all the liabilities repricing, it moved from a net asset repricing, which benefits in a rising rate, to a net liability repricing, which will benefit from a falling rate.
The degree to which they have been active in its management can be seen, but there’s been a £1 billion switch, and this can be compared to total assets of just £4.7 billion.
Q5: What can you tell me about the credit quality?
A: The statistics for most serious degrees have shown a strong improvement and the charge taken in 2024 in the specialist lending divisions was down in 2023.
Now, the core bank saw two situations where further charges were needed, one of which was due to a change in recovery assumptions on a long-term problem account. Private banking is very idiosyncratic in its losses, so they can come through quite lumpy and not necessarily related to the economy as a whole.
Q6: Are there any notes of caution?
A6: Management action has mitigated the effects of the exposure to falling interest rates, but it’s not eliminated it completely. The group has yet to see the full impact of inflationary pressure on its cost base, as well as its continued investment spend.
As always, there’s macroeconomic uncertainty, and the political environment globally has created its own uncertainties. Credit deterioration is an obvious risk, but Arbuthnot Banking Group has been conservative in new lending criteria. It tightened them again last year, and in taking security, which should reduce the probability of default and any loss in the event of default.
