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In March, Questor advised readers to sell OSB and was right to do so – shares in the specialist buy-to-let mortgage lender have lost a quarter of their value since.
This column is relieved to have sold before a profits warning in July that sent OSB shares tumbling. The lender disclosed a £180m hit because mortgage borrowers were refinancing more quickly. Broader investor unease about the banking sector, which prompted our advice to sell, has meanwhile persisted.
Now, however, we’re recommending the shares again, guided by the investment decisions of some of the world’s best-performing fund managers.
Ten of these professional investors – each among the top-performing 3pc of the 10,000 equity fund managers tracked by the financial publisher Citywire – own shares in OSB. As a result the stock is rated AA – just below a top AAA rating – by Citywire Elite Companies, which rates companies on the basis of their backing by the best-performing fund managers.
What’s more, many of those investors have been adding to their stakes over the past few months. They include Matthew Tillett, who bought more shares for his Premier Miton UK Value Opportunities fund in July. Tillett took over the fund in November last year after delivering four times the market return over three years on the fund he ran before.
He told his investors that shares in specialist lenders such as OSB were trading on valuations as low as those of Britain’s biggest banks, yet they were “less dependent on the interest rate environment to sustain high levels of profitability”.
Trading at just 0.6 times forecast book value, shares in OSB are close to the cheapest they have ever been on that measure and 30pc cheaper than when we advised readers to sell in March. A forecast dividend yield over the next 12 months that stood at 7.1pc when we sold has meanwhile climbed to 9.9pc – a level that suggests the market expects a cut.
But a trading update earlier this month indicates that the bank may be putting its problems behind it. There was no worsening of the situation that caused that big hit to profits from earlier in the year, when OSB was burned by borrowers spending less time between fixed-rate mortgages on stop-gap “reversion” rates that are lucrative for the bank.
Reassuringly, it left unchanged guidance for this year’s underlying “net interest margin” – the difference between the interest rates a bank earns on the loans that it makes and the rates it pays to depositors – at 2.6 percentage points. That would mark a recovery from the first half of the year, when the hit to profits resulted in a slump from 3 percentage points to 2.
That’s not to downplay the difficult trading conditions for banks and the particular challenges posed by the buy-to-let market, in which OSB specialises.
With interest rates starting to plateau, heightened competition between banks is curtailing rates on loans while the rates banks need to offer to attract depositors are rising. Increasing bad debts after the surge in mortgage costs, coupled with the impact of tightening regulation on the buy-to-let market, are adding to investors’ fears.
But OSB appears to be coping well with the pressures. Alongside the maintained net interest margin guidance, the bank reported a 5pc increase in deposits in the three months to the end of September. But the biggest positive from the third quarter was lending growth.
OSB reported that in the first nine months of the year it had achieved 7pc loan growth. This was previously the target for the whole of 2023 and guidance for the year has now been raised to 9pc.
Its ability to win market share thanks to its specialist focus is a key long-term attraction. It is also a reason to think it could weather tougher markets better than most as the specialist focus is reflected in the bank’s strong reputation for risk management.
On this front, there’s reassurance from low levels of problem loans and average rent-to-interest cover of 178pc on OSB loans and 154pc for its Charter Court Financial brand, which accounts for about 45pc of gross lending. Meanwhile, a scarcity of rental properties makes landlords well placed to pass rising interest costs on to tenants.
OSB’s resilience should also be helped by its bias to professional landlords who use corporate structures to secure tax and property management advantages.
This buy-to-let specialism keeps costs down compared with mainstream banks. OSB expects its costs to amount to around a third of its income this year, compared with more than half for many larger rivals.
The branchless bank’s low-cost model underpins its attractive levels of return on tangible equity. Even after the profit hit in the first half of this year, analysts expect the metric to reach 15.2pc in 2023 before rebounding to the high teens from next year.
It is not hard to see why, following the slump in the shares this year, top fund managers are betting that OSB’s valuation offers protection from further share price falls and the potential for significant gains should the third-quarter results prove to be a taste of things to come.
Questor says: buy
Ticker: OSB
Share price at close: 347.2p
Algy Hall is investment editor of Citywire Elite Companies
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