My favourite UK bank stock may just shock you...
UK bank stocks have been hammered over the past 12 months. A tax hike, regulatory issues and concerns about the UK's position in European financial markets after Brexit are just three of the factors that have sent investors fleeing from the sector during the year.
How each of these themes will impact banks isn't yet known, but what we do know is that all of the above are bad news for an industry still struggling to recover from one of the greatest financial crises in the history of money.
That said, not all banks are created equal, and some are better positioned than others to weather the headwinds facing the industry. And this is why I like challenger bank, OneSavings(LSE: OSB).
Under the radar
OneSavings is a company that flies under the radar of most investors, but in my view, it's one of London's most under-appreciated stocks.
Indeed, over the past few years, OneSavings has successfully taken on the UK's big four banks, carving out a niche for itself in the buy-to-let and business lending market. Pre-tax profits have risen from £31m for 2013 to £105m for 2015 and City analysts are expecting the company to report pre-tax profits of £139m for 2016. If the bank hits this target, pre-tax profits will have risen 350% in the short space of three years.
Unlike its larger peers, Lloyds,Barclays, HSBC and RBS, OneSavings has, to some degree, a more flexible business model. The group has no pre-crisis liabilities, isn't burdened with a huge network of high street branches and isn't constrained by old, inflexible IT networks. To put it another way, OneSavings is a bank built for the 21st century. If you're looking for evidence of this you need to look no further than its cost-to-income ratio, which was an impressive 27% for the first half of 2016. For the UK's big four the ratio is around 50%.
However, while OneSavings is more flexible than its larger peers in some ways, it's still held back by its size. Specifically, as a relatively small challenger bank, regulators require OneSavings to hold a higher ratio of capital than its larger peers. According to Metro Bank CEO Craig Donaldson, on mortgages, challengers hold 10 times more capital versus the big banks.
Even though challenger bank bosses are complaining that these higher capital requirements are holding back growth, for investors it's a mark that challengers may be safer in an economic downturn than their larger peers that hold less capital.
The bottom line
Overall, OneSavings is an under-appreciated bank stock that has more room for growth than its larger peers. And the firm's shares look cheap too. Shares in OneSavings are trading at a forward P/E of 6.9 and support a dividend yield of 3.5%.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Barclays and HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.