After three years as a listed company on the London Stock Exchange, Aldermore was taken private in March 2018 by FirstRand, South Africa’s second largest bank by Tier 1 capital. But what does the future hold for the UK challenger bank, at a time when the Bank of England (BoE) is phasing out its lending stimulus and interest rates are likely to rise? And what does the acquisition mean for Aldermore’s business strategy?
Former Barclays banker and Europe Arab Bank chief executive Phillip Monks founded Aldermore together with AnaCap Financial Partners in 2009 and has since been running the bank as chief executive. The speciality lender with a particular focus on banking for small and medium-sized enterprises (SMEs) – through products such as asset and invoice finance and mortgage and deposit products – as well as homeowners and landlords went public in March 2015 before being taken private by FirstRand.
“There are a lot of similarities in how the two businesses are managed,” says James Mack, Aldermore’s chief financial officer, who has been with the bank since 2013. “At FirstRand, many original founders are still in the business. That is something that was very important to us.”
Planning ahead
But there are differences, too: Aldermore has traditionally operated under an intermediary distribution model, without any branches, while FirstRand has a direct approach; and many of Aldermore’s mortgage customers use buy-to-let mortgages, a concept that does not exist in South Africa.
“The core Aldermore strategy persists,” says Mr Mack, while adding that the FirstRand takeover “helps us to accelerate our plans”, which could include the launch of current accounts in a move towards a more direct distribution strategy and an expansion of Aldermore’s business banking services.
“What the transaction gives us is more access to capital firepower, as well as knowledge and experience on how to develop different kinds of capabilities that we don’t already have in the UK but have been thinking about,” says Mr Mack.
The £1.1bn ($1.43bn) takeover by FirstRand received regulatory approval in February 2018 and saw Aldermore taken private by mid-March. Before the takeover, FirstRand already operated a branch in London as well as car loan business MotoNovo; the latter will be integrated and positioned under the Aldermore umbrella.
FirstRand expects there to be opportunities to cross-sell products between MotoNovo and Aldermore’s customer bases and through further developing financial services offerings in the longer term. But with the Brexit deadline around the corner, legislative pressures on the buy-to-let market and expected increases in funding costs for UK banks, does the investment come at the right time for FirstRand?
Decisive moment
FirstRand chief executive Johan Burger sounded clear in a statement in November, saying: “We are very comfortable that the financial impact of this transaction is supportive of FirstRand’s previous guidance to shareholders on growth, returns, capital position and dividend policy.”
Nevertheless, legislation to encourage first-time buyers in the UK and discourage buy-to-let investors introduced in the past few years is likely to start to bite. Stamp duty changes have already made investing in property less attractive, while a phased-in removal of tax relief on mortgage interest will further curb the market, affecting one of Aldermore’s strengths.
But Mr Mack believes that even though the buy-to-let market is “likely to shrink this year and next”, Aldermore aims to pick up “incremental market share” thanks to its “specialist underwriting, superior service for customers, speedier turnaround and the ability to think about more complex cases” than some of the bigger banks.
The specialist lender lowered its buy-to-let mortgage rates in March 2017, and in April 2018 reduced some mortgage-related charges for some types of landlords to attract potential clients. It also offers discounted rates to some existing customers.
BoE funding
Aldermore has shown some strong financials in the past few years. Underlying profits before tax increased by 20% in the 12 months to December 31, 2017 to £160m, following an increase by 34% in 2016. The lender kept its net interest margin (NIM) at 3.5%: of the UK banks listed in The Banker Database, only two banks reported higher NIMs at the end of 2017.
On the funding side, costs have been kept down because Aldermore, like other UK banks, was able to take advantage of cheap funds from the BoE. The Funding for Lending Scheme (FLS) (running from August 1, 2012, to January 31, 2018) and Term Funding Scheme (TFS) (September 19, 2016, to February 28, 2018) were launched to incentivise banks to lend to the UK economy in exchange for cheap funds.
Aldermore increased its loan book strongly during the period of the schemes, from £2.1bn at the end of 2012 to £8.6bn at the end of 2017, but a phasing-out of the cheap BoE funds at the start of 2018 means not only are funding costs likely to rise but also that lending growth could deteriorate in the near future.
Coming to an end
According to credit rating agency Moody’s, banks with total loan balances of between £1bn and £10bn at the end of June 2016 have taken the largest shares of TFS, proportionally.
Moody’s estimates that UK bank deposits will need to grow by about 5% a year for the next three to four years – more than 30% more than the historical average of household deposit growth – to compensate for the expiration of TFS and FLS funds. “To achieve this, banks will need to raise their deposit rates, absent a material increase in household disposable income,” Moody’s analysts wrote in a report on the impact of the end of cheap BoE lending on UK banks.
But even at current levels, time deposit costs are significantly higher than charges related to the BoE’s schemes. Loans under the TFS, which account for most of the outstanding central bank funding, are charged at the BoE’s current historically low base rate of 0.5%, while the average cost of new time deposits was 1.07% in May, according to BoE data.
Still, Mr Mack believes Aldermore is well prepared for the near future. The bank has a loan-to-deposit ratio of 119% to 121% and increased its deposit base by about 6% to £7.1bn in 2017.
“The TFS had been part of our regular funding approach but the end of it was well heralded, so we have been planning ahead for that,” he says. “We raised our deposit rates through the back end of November to start to wean ourselves off having funding come from the TFS. In the final six weeks, we did not take any funding from the TFS. Our last drawings were in early January.”
Overall, Aldermore drew about £1.6bn of TFS funding, according to Mr Mack, and will seek to refinance this “well ahead of the 2022 deadline”.
Securitisations to the rescue
Apart from deposit funding, Aldermore is also looking to return to the securitisation market after a four-year break, since issuing a £333m residential mortgage-backed securitisation (RMBS).
Following the expiry of the BoE stimulus, the bank is seeking to return to its earlier strategy with a benchmark-sized securitisation of about £300m, likely to be issued in the third quarter of 2018, something that Aldermore is aiming to repeat annually in future, according to Mr Mack.
Not only will there likely be more pressure on NIMs through increased bidding for deposits, but also an expected increase in supply of securitisations across UK banks could push up the costs of securitisation funding. However, Moody’s notes that “while we expect some increase in cost, investor appetite for securitisations is currently high” as the BoE programmes have “weighed on transaction volumes in recent years”.
A case in point is the favourable conditions Clydesdale Bank was able to achieve with the RMBS sold through its special purpose vehicle Lanark Master Issuer in February 2018. The issue priced with a five-year weighted average life margin of 0.42%, compared with the 1.63% margin of the bank’s 2012 issue.
Another potential source of funds could be the Royal Bank of Scotland’s £775m alternative remedies package to support banking services for SMEs, which the state-owned lender was obliged to agree to as part of its bailout programme. UK banks can apply for funding, which is split between £425m to facilitate investment in business services and £350m to support the switch of RBS customers to other lenders.
Aldermore is reviewing the opportunities which the RBS fund could provide in respect of business banking, according to Mr Mack, but is not including any potential allocations in its financial planning for the year.
New initiatives
Should Aldermore receive a portion of the RBS funds, the bank would be able to pursue new plans for new SME financing. Since going private it has already launched initiatives such as later-life lending, allowing people up to the age of 85 to access equity on their homes without having to sell.
In January, MotoNovo launched its online platform, findandfundmycar.com, which aims to disintermediate vehicle aggregation sites such as Autotrader. The idea behind it is to “use the platform as an ecosystem”, says Mr Mack, who adds that the strategy is not only to own the distribution channel but to offer a one-stop shop for finding, financing and potentially insuring vehicles. Aldermore might at some point even consider launching a similar project for homes, should the car platform experience be positive, all part of Aldermore’s no doubt interesting future.
