OneSavings Bank: rational customer behaviour pummels bank’s market value

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Challenger banks aimed to disrupt a cosy, concentrated UK banking system. On Friday, shareholders in OneSavings Bank found themselves faced with a challenge of their own. OSB announced an unexpected £160mn-£180mn write down on part of its mortgage book. The share price nosedived 28 per cent.

This sharp reaction says more about investor jumpiness towards banks than any hit to OSB’s earnings. Post-tax, this loss equates to about 30 pence per share, worth about 6 per cent, says Edward Firth at KBW.

The response also reflects concerns about the murkiness and subjectivity of bank accounting. This comes despite OSB’s high common equity tier one ratio of 16.3 per cent as of March.

Measuring the income of companies that make and sell stuff is usually straightforward. Costs, prices and volumes matter most. Financial institutions rely more on models that calculate current values for assets and liabilities held for long periods. Small changes in discount rates can cause major valuation swings.

That has happened here. OSB’s Precise Mortgages business is responsible for nearly 44 per cent of the group loan book. Its borrowers have moved more quickly to fix new mortgage terms when older contracts ended than in the past. Less time (reversion periods) spent on pricier variable rate loans, based on the Bank of England base rate, meant less interest income for OSB. IFRS 9 required an adjustment.

One might ask why an OSB borrower would move to a higher variable mortgage rate for more than a year. In the ultra low rate era, some found those rates more appealing. No more. This reversion period has fallen to five months, says OSB.

That period could reduce again, requiring another earnings charge. Other OSB mortgage businesses have shorter reversion periods, one to two months, as do rivals Virgin Money and Paragon. Their share prices also fell on the day, but much less.

Banks once promised higher interest rates would lead to higher profits. That linkage now looks a lot less clear.