OneSavings Bank's profits surprise

Challenger banks crashed following Britain's decision to leave the EU. Investors feared lower interest rates, a slowdown in mortgage demand and rise in unemployment could spell disaster for the sector. Results, however, have been pretty good and latest numbers from OneSavings Bank are the catalyst for the latest leg of a dramatic recovery.

First-half underlying pre-tax profit, which strips out the £34.7 million OneSavings made on the sale of its Rochester vehicle in May, surged by 36% to £64.6 million. That's £4 million more than expected, thanks largely to much smaller-than-anticipated impairment charges and substantially lower regulatory provisions.

A 27% surge in underlying earnings per share (EPS) to 19.7p was 10% higher than estimates, and underlying return on equity (ROE) of 29% also beat forecasts.

The loan book, meanwhile, swelled by a tenth to £5.4 billion, and net interest margin (NIM) - the difference between interest paid to depositors and interest earned on lending - improved slightly to 3.07%, marginally ahead of full-year guidance. Chief executive Andy Golding expects a similar outcome for the 12 months.

Encouragingly, he also reveals that application levels in OneSavings' core businesses since June are "significantly" higher than the first-half run rate.

"It is too soon to predict the medium to long-term impact of Brexit on the UK economy, but we will continue to concentrate on what we have proven we do best; using our broker relationships, manual underwriting expertise and secured lending strategy to lend responsibly to customers in underserved markets," Goldings says.

It's fair to say Peter Lenardos at RBC Capital is impressed. The analyst upgrades EPS forecasts for 2016 by 9% to 40.4p and by 6% for next year to 40.3p. That prompts a ratings upgrade to 'outperform' and a hike in the price target to 290p from 260p.

But even that could be conservative, admits Lenardos: "Even though we increase our forecasts in an uncertain economic environment, we believe that absent a material house price correction or a severe and/or sustained recession, and given the upside optionality provided by OSB's strong balance sheet, our revised, higher forecasts present an achievable (and possibly conservative) picture of the company's growth trajectory.

"This is because our forecasts continue to assume a moderation in the net interest margin, an increase in the cost:income ratio, a near doubling of the impairment ratio, slowing loan book growth, and a material decline in the return on equity (the latter of which could be rectified by an increased payout ratio)."

OneSavings Bank shares were up over 13% at one point on Wednesday at prices not seen since before the post-Brexit plunge gathered pace. They're still down over 20% from their pre-'Leave' vote levels and, despite surging by 54% from their June low, of its rivals, only Shawbrook has done worse during the third-quarter.

"Thus, in our opinion the relative underperformance presents an attractive entry point to a best-in-class performing company, as OSB's return on equity remains peer group leading," adds Lenardos.

OneSavings currently trades on just 6.5 times forward earnings and offers a prospective dividend yield of 3.8%.

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.