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: Now we are talking about Arbuthnot Banking Group today. You’ve called your recent note, “2025 lower margins, 2026 profit stability”. Can you give us a short summary of your key findings?
A1: Arbuthnot’s 2025 results contained a number of key issues. The first was strong growth in low capital intensity businesses such as deposits and wealth management. It also saw growth in high risk-adjusted return specialist lending, particularly to the commercial sector. Arbuthnot continued to walk away from business that did not meet its target returns, so there was a fall in the core banking book.
Now, pre-tax profits fell by 31% on 2024, and this was due to the well-flagged, and hopefully well-known, impact of the falling interest rate environment. There was lower private equity-backed activity in its asset-backed division, and there were low truck resale profits. They were partly offset by a one-off £3.25 million gain but the key driver to the fall in profits was the falling interest rate environment.
A higher-for-longer interest rate environment, perhaps due to the Iran war, will aid deposit margins in 2026. We are forecasting a 2026 yield of near 7% and cover of over two times as profits stabilise.
Q2: So you mentioned earlier that the profits fell. What was it that drove the profits down, and was it expected?
A2: As I said, profits were down 31%, and yes, it should have been expected. The key driver was the falling interest rate environment, which we have discussed in detail in multiple previous notes, and which was well-flagged and hopefully expected.
There were lots of moving parts, but the group really optimised returns in the previous rising rate environment, and that set a very high bar. When interest rates started to fall, the company’s multiple mitigation actions were insufficient to offset the lagging effect of large fixed-rate deposits. These only reprice when they mature, so there is a lag, and they become expensive for a while.
On top of this trend, there was some noise in a couple of the specialist lending businesses, as I mentioned, with low PE-backed asset-backed lending, due to slow activity in that market, and well below normal profits on the sale of trucks in the leasing division.
The latter is a result of the hangover from COVID-19 and the disruption to supply, and demand seen at the time, and the impact that had on secondary truck sales. We expect the noise to moderate over time, and with a longer-for-higher interest rate environment due to the Iranian war and ABG’s mitigation efforts, we expect there to be stable profits in 2026 and then rising ones in 2027.
Q3: You mentioned the war there a couple of times. What do you see as the overall impact of the Middle East conflict on ABG, on its outlook?
A3: It obviously remains an uncertain outlook, but assuming a resolution of the conflict within the near-term future, we expect higher deposit income from the higher-for-longer base rate, wider loan spreads to reflect the macro risk environment, potentially some market gains in the loan market, as loans which previously did not meet Arbuthnot’s hurdle rates now do so.
The market gain will offset potentially lower market-wide overall loan demand. We saw very good improving 2025 credit metrics and conservative lending approaches make any impairment deterioration as a result of the economic uncertainty likely to be modest.
As I said, all of this assumes resolution in the near-ish future.
Q4: What about the credit quality? You said 2025 showed improvements. How much was that and why?
A4: 2025 saw the falling higher-risk loans, which in accounting terms are classified as Stage 3, they were down by about 20%. What might be regarded as more medium-risk loans, Stage 2, nearly halved.
There are also falling early-stage arrears, which is a lead indicator for future losses, with total loans which were 30 to 60 days in arrears at just £3 million compared to £16 million at the end of 2024.
Overall, in 2025, the loss rate was a minimal 10 basis points in the year.
Q5: Are there any notes of caution, Mark?
A5: All investments carry risks. Management action to mitigate the falling interest rate environment has reduced the exposure, but not eliminated it entirely, so further base rate cuts will impact on profits.
As always, there is macroeconomic uncertainty and the political environment creates its own uncertainties too. Credit deterioration from them is an obvious risk, but Arbuthnot Banking Group has been conservative in its lending and taking very good security throughout.
These should both reduce the probability of default and any loss in the event of default.
