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Atom Bank: Yet another Woodford cash-guzzler – more funding required

By Cynical Bear | Sunday 28 January 2018


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.


Pointed in its direction by Robert Dwek in the comments on my last Woodford piece, I thought I would write an article on the hugely capital intensive Woodford portfolio holding, Atom Bank, a start-up bank. A bit of a long read but I found it quite intellectually interesting looking at the challenges facing a start-up bank and it also throws up one of the first major funding issues for Woodford caused by the predicament he has recently got himself into.

At a high level, Atom Bank sounds like a pretty compelling idea. Set up a mobile-only bank with technology at its core that will be able to operate with a much lower cost base than traditional rivals and provide better rates for customers as a result. In the longer term, it will use all the data it obtains to transform banking as you know it….yada yada yada.

Life has proven to be more difficult in practice.

Going back to basics, a bank is a pretty simple business. It takes in money from customers whether that be through current or savings accounts paying those customers as little interest as it can get away with and then it lends that same money out again at much higher rates for personal or business loans and mortgages. The difference between the two is the bank’s net interest income – its main revenue line – and the high street banks currently operate at a net interest margin of anywhere from about 2% to 3.5% of assets depending on the type of business they take on.

The issue that Atom Bank faced when starting up is how to attract customers and, quite understandably, it decided to focus on savings accounts only and offer very attractive rates. Using this tactic it has quite quickly built up customer deposits of about £1 billion. However, as it does not benefit from offering low interest current accounts, its interest expense is high and must average about 2%.

Accordingly, even if all those deposits had been lent out, I would expect Atom Bank to find it difficult to exceed a 2% net interest margin as their business model currently stands. There was talk of offering current accounts which would help significantly but that seems to be have been deferred due to regulatory complexities.

The reality is worse in the short-term as it has been unable to lend the money out quite so quickly as it would like. As at May 2017, it had £140 million lent out with the rest of the cash sitting on the balance sheet earning a relatively low inter-bank rate.

Accordingly, for the period to 31 March 2017, it had negative net interest income and I would be surprised if it has generated positive net interest income in the financial year to date due to this major mismatch of the assets and liabilities.

The obvious answer is to lend more but this gets to the second substantial challenge facing a start-up bank – the need for significant capital.

All banks need to hold a certain amount of regulatory capital to support its activities. In simple terms, it needs to have a capital buffer to ensure that it can pay out its customers should they want their money back and the more it lends out to other parties, then the higher the buffer required. I won’t go into the ins and outs of Tier 1 Capital and how one calculates risk weighted assets (RWA) , but, simplistically, one needs equity, less intangibles, of somewhere between 10-15% of your RWA, the higher the better.

The bank’s RWA is largely linked to the nature of the lending so the higher the risk, the higher risk weighting. As an example, at 31 March 2017, Atom Bank had lent out £99 million and its RWA was £157 million. This ratio would come down substantially over time but I estimate that with £1 billion lent out it would need roughly £100 million of Tier 1 capital.

Up to the latest accounts to 31 March 2017, Atom Bank had raised £164 million principally from Spanish bank, BBVA, that owns 30%, Woodford (obvs) with over 20% and Toscafund. Woodford holds it oin both WPCT (4.24% of portfolio) and the Equity Income Fund (0.55% of portfolio).

As at 31 March 2017, Atom Bank had approximately £70 million in Tier 1 capital but that would have been reduced by losses and any capex on intangibles and so, I expect most of that capital has gone by now, hence why more capital has been going into the bank on a regular basis as follows to fund losses and future growth:

April: £14 million

July: £22 million

November: £43 million

So I calculate that, in total, the astonishing amount of £243 million has been invested in Atom Bank so far and it is probably yet to generate net interest income and, as things stand, I doubt it has enough sufficient capital as things stand to lend out all its current deposits, let alone fund growth!

It also has an ongoing cost base of £40-50 million to fund and more capital is needed, much more. It has publicly stated that it is trying to complete a £150 million round at the moment - I am assuming the recent November infusion is part of that. The issue is though that’s not going to get it anywhere near where it needs to get to and losses are going to eat into that pretty quickly stymieing growth on the assets side again.

Assuming a 2% net interest margin, I estimate that this business needs to reach about £3 billion assets to break-even, which would need over £200 million of capital sitting there as a buffer and to make significant profits much more is needed, the same again probably and it also has to fund losses along the way. So how much is needed from now to get to a nicely profitable business? Perhaps another £400 million or more say and that’s if the business executes its business plan effectively and can actually lend out that much.

The trouble is where do the funds come from in the short-term, let alone the longer-term? It appears that Woodford Patient Capital Trust (WPCT) has put in about £10 million in November but is now maxed out (not that it mentioned it in the monthly update) and it seems that BBVA remains supportive and will put in their 30% but what about the rest? Most normal investors won’t invest in such an early-stage proposition and a VC-type fund would want a much lower entry price to try to generate a suitable return.

In times gone by, well about six months ago, Woodford would have chucked in another £50 million or so from the Equity Income Fund in the blink of an eye and encouraged others to follow suit but I don’t think that is possible now due to the unquoted stock limit and doubt it would be palatable for its investors, many of which are presumably threatening to redeem if he buys any more of that unquoted crap.

This is the first big test of the Woodford liquidity issue and it will be fascinating to see how it plays out. The fact that Atom Bank’s founder and Chairman, Anthony Thomson, stepped down last week isn’t particularly encouraging.

The one potential saving grace for Woodford here is BBVA, who may just want to avoid any embarrassment and buy out the whole thing at a good price for the other investors and fund it itself going forward. It wouldn’t be the first time that a strategic trade purchaser has overpaid for an asset in these sorts of circumstances to save face in the short term.

I will watch with interest.


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