Aldermore: Challenger banks are growth stocks

Peter Lee
Published on:

As the UK economy picks up and loan demand rises amid a continuing scarcity of supply, equity investors will have the chance to play this theme through a new and growing sub-sector of challenger banks. Investors, however, still face a challenge in valuing Aldermore's IPO.

Phillip Monks-envelope
Chief executive Phillip Monks says 'Aldermore is a modern, legacy-free bank that challenges the established view on what banking should be'

Fast growing, focused on a handful of underserved client segments where loan demand is high and margins robust, efficient, with modern and scalable IT, unburdened by legacy costs from mis-selling or other wrong-doing, well-capitalized and increasingly profitable: Aldermore doesn’t look much like a UK bank.

But in October it will become the third UK bank to float this year, following the carve out flotation from Lloyds of TSB in June and the IPO in the same month by JC Flowers, the specialist private equity investor focused on financial services, of OneSavingsBank, the remodeled Kent Reliance Building Society.

There is much that looks attractive in Aldermore’s pitch to investors. It lends to SMEs and homeowners, specializing in asset finance, invoice finance, SME commercial mortgages and residential mortgages. Much of its lending is therefore collateralized. And it is targeting areas where other banks have withdrawn and borrower demand is high.

Since its founding in 2009, backed by private equity funds led by AnaCap Financial Partners and with a management team experienced in regional banking in the UK led by chief executive Phillip Monks, who had been director of business and corporate banking in North West England for Barclays, Aldermore has grown fast. 

Banking analysts on the buy side have been coloured by the crisis, the legacy and regulatory issues that have emerged
ECM banker

In May 2009 it started life with £76 million of deposits and 50 employees. When it announced results for the first half of 2014 last month, it showed £4.8 billion of assets, 160,000 customers and over 800 employees. Loans have almost doubled since the end of 2012 with much of that funded from SME and retail deposits gathered online. 

The bank reports a loan-to-deposit ratio of 104. It has diversified funding into residential mortgage securitization. It generated profits of £18.6 million for the first six months of 2014, three times greater than the same period in 2013 and generated an 11.7% return on equity with a fully loaded CRD IV common equity tier 1 ratio of 11.7%.

The IPO is due to price in the third week of October and is expected to be for around £300 million, with £75 million of that in primary funding to plough back into the business to support further growth until that growth becomes self-funding after 2016. The bulk of the sale, however, will be first round investors cashing out.

Who will want to replace them? "Normally when you do the IPO of a growth company outside the banking sector, they are sold to sector, mid-cap and growth investors," says one ECM banker not on the deal. 

"But banking stocks are different. Banking analysts on the buy side have been coloured by the crisis, the legacy and regulatory issues that have emerged. So the vendors and their leads will have to triangulate between banking specialists, mid-cap and growth investors and try to manage the bank analysts’ traditional pre-occupations with low growth, regulatory and legacy cost issues and valuing banks on a price-to-book basis rather on a forward price/earnings ratio typically to reflect the embedded earnings growth. So there’s a challenge there." 

He says: "I certainly think US investors used to growth banks will be interested."

Good time to sell

It suddenly feels like a good time to sell UK banking stocks, as the economy recovers and loan demand picks up. The success of Lloyds in selling a quick follow on tranche of TSB stock at the end of September has fuelled speculation that Virgin Money may bring forward its plans for a flotation that had been scheduled for next year. 

Metro Bank, another new entrant, also harbours plans to float. Last month Barclays bank analysts came back from meetings with management at OneSavingsBank, following good results from the specialist lender that has a big business in buy-to-let mortgages, with promising news. While profitability across the bank's books of business is showing a 30% return on equity, new business is even better at around 40%. "They had expected competition to increase and erode some of this, but they are not yet seeing any downwards pressure on asset yields."

Aldermore’s management team wants to focus investors beyond the bank’s initial growth spurt on its ambitions to deliver what it hopes will be normal returns beyond 2017 when it aims to be generating a 20% return on equity, driven by a cost/income ratio of 40%, down from 64% today. 

The key to this is operating leverage. Free from the burden of branch costs, it should not cost too much more to originate a higher volume of assets and funding from its online platform and regional offices. Revenues should, so the theory goes, grow faster than costs.