They could be contenders. Smaller British lenders known as challenger banks have swaggered about of late, thanks in part to a significant merger agreed upon last month.
CYBG CYBG, +0.48% , the parent of Clydesdale Bank, Yorkshire Bank, and app-based bank B, has vowed that its $2 billion takeover of peer Virgin Money Holdings VM., +0.31% will turn it into the “first true national banking competitor” to the United Kingdom’s banking giants, rather than just a challenger.
For investors, the question now is which stocks in this plucky sector—filled with tech-savvy start-ups and refreshed old brands—look like the best bets, especially given that CYBG and Virgin Money’s shares have rallied on merger hopes. But other players still could attract buyouts.
Charter Court Financial Services Group CCFS, -1.19% and OneSavings Bank OSB, -0.19% should be your first pick and second choice, respectively, according John Cronin, an analyst at Irish brokerage Goodbody. One reason to feel bullish about these two members of the mid-cap FTSE 250 index MCX, +0.00% is their exposure to the growing buy-to-let market, Cronin says—lending to people who are buying properties in order to rent them out.
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In large part for that market, challenger banks end up being “overcompensated relative to the risks that they’re running,” the analyst tells Barron’s. “While the risk profile of the lending is higher than what mainstream banks do in terms of mortgage lending, the spread is higher, too.”
The larger banks will encroach on the buy-to-let market in the long run, but it looks promising for challengers, at least for the medium term, Cronin says. And while the U.K.’s housing market has been cooling, and some reports have described the recent buy-to-let boom as ending, thanks in part to new regulations, he sounds upbeat. However, he acknowledges pain will come if home prices dive due to a chaotic “no deal” crash out of the European Union by the Brexit-bound U.K.
“All the banks are going to be in trouble, effectively, if we have a calamitous drop in prices. But what’s going on now is absolutely manageable, because these new challenger banks are implementing pretty strict loan-to-value and loan-to-income criteria,” says Cronin, whose team has put a price target of 505 pence ($6.64) on Charter Court and sees OneSavings hitting 526 pence, implying rallies of about 50% and 20%, respectively. Each stock gets a Buy rating.
Charter Court also draws praise from Cronin for boasting a “low-risk business model, because it has best-in-class underwriting.” In addition, he likes how it’s “creating value by selling its residual interests in securitizations.”
OneSavings, meanwhile, is a possible takeover target, the analyst says, if private-equity firms think it’s trading at “an undemanding multiple relative to the returns that it can generate.” OneSavings changes hands at eight times forward-year estimated earnings, as does Charter Court, while each challenger bank’s price-to-book ratio is just above two. CYBG also might want to buy OneSavings eventually, or Charter Court could step in, as it may be “a consolidator in time,” he says.
Other fans of OneSavings include analysts at British brokerage Numis, who say in a recent note that its price “offers good value.” They have slapped an Add rating on the stock, along with a price target of 470 pence, implying a rally of about 8%.
This report also appears at barrons.com.
