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Eager to disrupt the UK banking system, challenger banks faced a daunting task. However, last Friday, OneSavings Bank shareholders were confronted with their own challenge. OSB unexpectedly announced a £160mn-£180mn write-down on a portion of its mortgage book, resulting in a 28% drop in share price.
This sharp reaction primarily demonstrates investors’ apprehension towards banks rather than a significant blow to OSB’s earnings. Edward Firth at KBW estimates that this post-tax loss represents approximately 30 pence per share, or around 6%.
This response also highlights concerns about the complexity and subjectivity of bank accounting, despite OSB’s strong common equity tier one ratio of 16.3% as of March.
Measuring the income of companies involved in manufacturing and selling is usually uncomplicated, focusing on costs, prices, and volumes. However, financial institutions heavily rely on models to calculate current values of long-term assets and liabilities. Small changes in discount rates can result in significant valuation fluctuations.
OSB experienced such a scenario. Precise Mortgages, contributing nearly 44% to the group’s loan book, witnessed borrowers opting to fix new mortgage terms more quickly when older contracts ended. As a result, the reduced time spent on higher variable rate loans linked to the Bank of England base rate led to decreased interest income for OSB. Compliance with IFRS 9 necessitated an adjustment.
One might question why an OSB borrower would choose a higher variable mortgage rate for over a year. During the era of ultra-low rates, some found these rates more enticing. However, this reversion period has now fallen to just five months, according to OSB.
If this period declines further, another earnings charge may be required. Other OSB mortgage businesses, as well as competitors Virgin Money and Paragon, have shorter reversion periods, lasting one to two months. Although their share prices also dipped, the drop was not as significant.
Previously, banks promised that higher interest rates would lead to increased profits. However, this relationship no longer appears as clear-cut.
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