For London’s mortgage lenders, curveballs smack much harder in today’s market. That seems to be the prime explanation for the near-30 per cent dive in the share price of OSB Group at the end of last week.
The FTSE 250 banking group, which specialises in lending to buy-to-let landlords, expects to take a hit of £160 million to £180 million to its interest income for the first half of this year, equivalent to about a fifth of the total income analysts had forecast for the year as a whole.
Why? Canny borrowers are refinancing fixed-term mortgages faster, spending less time on the higher variable rate that they are switched on to once the term of their mortgage expires. Analysts have downgraded forecasts for the net interest margin this year to 2.69 per cent, from 3.04 per cent.
The speed and scale of the rise in mortgage rates, which will hit transaction levels and will render repayments less afordable, has made investors tetchy. Shares in OSB now trade at a 31 per cent discount to the book value that analysts have forecast for the end of December, close to the lowest level since the challenger bank was launched on London’s main market in 2015. That leaves a high margin for error, which should alleviate remaining shareholders’ nerves.
Up until the end of last year, customers had stayed on the variable rate for about 17 months. OSB has marked that down to five months across its back book of Precise Mortgages business. That more conservative five-month assumption is now being applied to all new business written. The rump of any charge relating to the amount of additional income that OSB generates from customers sitting on variable rates should have been taken already.
What about its core Kent Reliance business? The difference between the fixed and variable rate was already far greater than that for Precise Mortgages customers, which had pushed a higher proportion of these borrowers to refinance once their initial term was up. There should be less risk of a sizeable markdown in interest income here.
The markdown might be backwards-looking, but that doesn’t mean it is only earnings expectations for this year that need a rethink. Analysts have cut earnings expectations by 4 per cent for both next year and 2025, according to data compiled by Factset, given that less time spent on variable rates should mean the net interest margin is less fat than the market had anticipated. A markdown in earnings assumptions for this year and next year means the dividend should also be reassessed. Analysts at Shore Capital reduced their forecast for this year’s ordinary dividend to 35p a share, from 40.3p pencilled in previously, and also cut next year’s figure to 44p, from 46.5p. This year’s £150 million share buyback programme should be secure.
OSB thinks it can churn out about 7 per cent loan book growth this year, less than the 12 per cent delivered last year and the pre-pandemic level, but better than the 5 per cent figure trailed in March. Impairment losses increased to 0.14 per cent of gross loans and advances last year, but that is still about the same level as pre-pandemic. At the end of the first quarter, arrears in excess of three months were stable at 1.1 per cent of the loan book.
Regulatory capital levels are far higher than the regulatory minimum, with the common equity tier one ratio standing at 18.1 per cent at the end of December and forecast to fall to only 16.3 per cent at the end of this year by Numis, the broker.
OSB is priced for catastrophe, but that shouldn’t be the base assumption.
ADVICE Hold
WHY The shares’ discount accounts for the risk of any further markdown in interest income
JPMorgan Japanese Investment Trust
The Japanese market is no stranger to false dawns, but not since the 1980s have investors piled into Tokyo-traded stocks at such a pace. For JPMorgan Japanese Investment Trust, the largest in the London-listed sector, the fruits of the market rally have been harder to reap. Why? Because of a bias towards “premium growth” companies, many of which have higher valuations and were caught up in the sell-off in the first half of last year.
Japan has not experienced the same rapid monetary tightening as in the United States and Europe, but there has been the same shift away from stocks that are optimistically valued. That’s been exacerbated by the sell off in so-called Covid winners, the likes of Sony, the eletronics group, and Keyence, a robotics specialist, which together account for almost 15 per cent of the trust’s assets by value.
That six-month hit has left five and three-year performance figures trailing its benchmark Topix index. Over a ten-year period, the value of the trust’s assets has risen by 137 per cent, against 101 per cent for the yardstick it seeks to beat. More recently, the expectation that interest rates in developed markets could be nearing a peak has pushed the value of its assets up by 7.6 per cent, ahead of 4.4 per cent from the index.
A pandemic rebound and fresh impetus to return surplus cash to shareholders have lit a fire under the world’s third largest equity market. Half of the companies listed in Tokyo have a net cash position, compared with about 15 per cent in America and Europe. The Japanese market also trades at a discount to its historical average, based upon its cyclically adjusted price/earnings ratio. An increase in inflation to only 3.2 per cent is a fillip in light of the deflationary pressures that have plagued the Japanese economy. All three could prove more enduring catalysts for Japanese stocks.
The trust has one of the cheapest continuing charges in the sector at 0.68 per cent. Like its peers, it has traded at a stubborn discount to the value of its assets. A stabilisation in the interest rate outlook and a further return of cash by Japanese companies could address the gap.
ADVICE Buy
WHY Improving returns and corporate governance reforms are not reflected in the discount
