Ninepoint International Small Cap Fund Market View

May 24, 2019

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Dear clients and colleagues,

We recently reduced our under-exposure in the financial sector. One company we added to our portfolios is OneSavings Bank.

OneSavings Bank (OSB), a UK challenger bank, focuses on the professional landlord buy-to-let market. In addition to the buy-to-let market, the bank is also involved in residential, commercial and high-networth lending. OSB conducts the majority of its buy-to-let business in the greater London area and in the Southeast UK. It distributes its product mainly through a large number of intermediary brokers. Its average loan is £260,000, and the entire lending book is secure financing. Despite ongoing investment in the business, OSB has delivered great performance over recent years.

Looking at OSB’s fiscal year 2018 results and Q1 trading updates, we find that revenue, costs and impairments were all better than expected. OSB is one of a few banks that can deliver good top- and bottom-line growth while maintaining a strong return on equity of above 20%. The stock appears cheap, trading at 1.4x tangible book value, 6.5x expected 2019 earnings and offering a 3.6% dividend yield.

OSB recently proposed a merger with another bank, Charter Court. If approved by their respective boards, the new combine entity will represents one of UK’s biggest specialist lenders. The new group is expected to benefit from a better-diversified loan book and a more varied source of funding. The cost synergies realized should offset the higher insurance costs.

Market size

• The buy-to-let market in the UK is estimated at £35 billion in gross lending terms.
• Approximately 90% of the lending application flows are from professional clients.

Growth strategy

• Organic origination by rolling out its old book of business.
• Gaining share from traditional lenders. Stricter mortgage rules for applicants tend to lead to
  further professionalization in the buy-to-let segment.
• Developing new banking products, possibly in the owner-occupied business or in the asset
  financing segment.
• Could do securitization to acquire new business

Strengths

• One of the market leaders in the buy-to-let specialist market with 5% market share.
• Strong return on equity (ROE) that translates into a good level of capital to support investment
  in the business.
• Strong relationships with brokers to facilitate efficient distribution of its products.
• Quality over price. OSB does not sacrifice returns for volume as it tends to be slightly more
  expensive than its peers.
• Uses a mix of manual and technology-assisted processes to reach a lending decision. This leads
  to a slower process but generates very strong conversion rates.
• Combines a good growth profile with sound profitability.

Opportunities

• Specialist lenders are gaining market share over traditional banks.
• Lower real estate prices combined with a weakening of the pound has created some
  opportunity in the professional buy-to-let market.
• OSB will be applying to use the Internal Ratings Based (IRB) rules this year. If granted, its capital
  requirements would drop.
• Stricter regulatory requirements tend to be an opportunity for challenger banks like OSB. As
  affordability criteria become more stringent, challenger banks tend to be better-positioned
  than traditional banks.
• Diversifying into other product segments.
• There is some consolidation in the specialists/challenger bank space.

Risks

• Slowdown in the buy-to-let market.
• Funding costs could pressure margins.
• OSB is facing competition from traditional banks to other challenger banks.

Have a good week.

The Global Alpha Team