IPO window open for Metro Bank

It's official: Banks are back in fashion. After years of chronic underperformance, investors are now betting that UK lenders are over the worst and beginning to look good value. In the past week, the UK bank sector is up 10% compared with less than 3% for the FTSE All-Share index. Lloyds Banking Group was a massive driver, and even struggling Standard Chartered is backed as a recovery play despite a shock $1.5 billion (£1.1 billion) annual loss.

Given the dramatic sea-change in sentiment, might now be the time for Metro Bank to get its float away?

Well, yes, according to reports. Shares in the so-called challenger bank are tipped to begin conditional trading on Monday and be available to retail investors for inclusion in SIPPs and ISAs on Thursday.

It would certainly be opportune of Metro. The plunge in global stockmarkets to multi-year lows mid-February persuaded the lender to scale back its listing, cut the offer price and delay the float by a month.

Now, not only have financial markets calmed down, but we're in the middle of results reporting season. The high street banks failed miserably for the most part, but Metro's peers are doing far better than expected.

And, after bailing out of the sector last year following the government's crackdown on buy-to-let mortgages, investors are piling back into challengers like Aldermore, Shawbrook and Virgin Money.

Piling into the challengers

And no wonder. Virgin has just unveiled an underlying pre-tax profit of £94 million for the second half of 2015, about 11% better than the City expected. "Clear evidence of an under-appreciated and sustainable growth story," argues Investec analyst Ian Gordon. Income, costs and impairments all beat estimates and the share price is up over 40% in less than four weeks.

Shawbrook, about half the size of Virgin, has also smashed forecasts with a 63% surge in profit last year to £80.1 million. After listing 11 months ago, its shares fell below the 290p IPO price in February this year. But they're up 22% inside a week and back in the black.

Of the other challengers, Aldermore reports on 10 March and OneSavings Bank a week later, and hopes are high. Look for adjusted pre-tax profit of £90.6 million at Aldermore and £97.8 million at OneSavings, according to Peel Hunt analysts, up 80% and 54% respectively.

Potential pitfalls

Clearly, there are potential banana skins. The 3% increase in stamp duty on second homes and buy-to-let from 2016 could reduce demand for mortgages. So could restrictions on higher-rate tax relief on buy-to-let interest payments from 2017.

Some also want a rise in residential buy-to-let mortgage risk weightings from 35% to 120%. Challenger banks must maintain a higher level of capital than their established rivals, which is why they tend to gravitate toward specialist business like buy-to-let. A further change here would dramatically increase the money these banks must put by to cover potential losses.

An economic downturn and further prolonged period of low interest rates would be unhelpful, too. Yet, the challengers trade on a sector price/earnings ratio of just 8 times for 2016, or a price-to-net asset value of 1.6 times, for return on equity of 21%, according to Peel Hunt.

"Although we conservatively forecast some deterioration in the level of returns in coming years, in our view the current share prices are overly pessimistic with regards to the future earnings trajectory," says the broker, forecasting compound earnings growth of 13% over the next three years.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.