The penny share filling banking's black hole

With banks still reluctant to lend, credit is tight for most small businesses. Here, Tom Bulford looks at one small-cap finance company that's filling this valuable niche, and making handsome profits on the way.

There's only one thing I remember about the economics degree I studied for 30 years ago. That's because it was the only lesson that seemed to have any relevance to the real world. It's that price is determined by supply and demand.

Whenever I assess penny share companies I always come back to this. Whatever product or service the company provides, I ask myself three questions:

What is the level of demand out there?

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

What will be the level of supply?

And at what price will the two be matched?

Today I want to think about this in relation to UK banking. I am sure you've heard it said that bankers will only lend you an umbrella when the sun is shining. This has always seemed to be the way of things.

When the economy is rosy, when the prospects for loan repayment are apparently good, they will lend you as much money as you want and send you on your way with a friendly smile.

But these days the economic conditions are far from rosy. Now, at the very time when borrowers need all the help they can get, the bankers are stony-faced.

Recommended reading

We must remember that banking is a cyclical industry. In this respect it is no different from the hotel industry. In the good times it expands and in bad times it hunkers down. But it need not be like this.

A lesson that the bankers could do to learn

A shrewd banker could have piled up the profits he made in the good times so that now, when desperate borrowers are prepared to pay high prices for loans, he could make the most of it. A good hotelier would have hoarded the money made in the good years and now, when the price of hotels is low, he would be investing ahead of the next upswing.

Other small-cap news

  • Shares in the niche engineering group Specialist Energy Group (ticker: SEGR) moves up 4% after a positive trading statement revealed a £14m upturn in profits since January.
  • SEG's main subsidiary, Hayward Tyler, is enjoying strong demand for its products especially from the Asian power market.
  • Hayward Tyler recently provided four synthetic gasification (Syngas) cooler pumps for "one of the largest Syngas project in the world".

But cyclical industries rarely work like this, as the case of UK banking amply demonstrates. Having gone lending-mad in the boom time, the bankers have now pulled down the shutters with a vengeance.

Borrowers lucky enough to be granted a loan have to pay handsomely for the privilege. With the Bank of England holding interest rates as low as it dares, depositors are offered feeble returns.

And it does not take a degree in economics to work out that demand for loans exceeds supply, so that the lending business today offers handsome returns.

One penny share aiming to exploit the win-win conditions in the banking sector

One company that intends to take full advantage of these conditions is Private and Commercial Finance (LSE: PCF).

Chief executive Scott Maybury bent my ear last week to tell me that he is hoping to secure a large line of capital with which to expand his lending business.

Image removed.

Claim your special FREE report: 10 simple rules for maximising your penny share profits

  • Receive the stock market wisdom of a top-level penny share expert
  • Your essential guide to playing the small caps market

PCF is right at the sharp end of the economy, making loans of a few thousand pounds so that those in the small business sector can buy vehicles and vital equipment.

Last week it announced a doubling of profit to £528,000, but rather than congratulating himself on the achievement, Maybury said that this profit level is "below our potential", adding: "There are some excellent opportunities available in our sector resulting from reduced competition, and we intend to do all we can to take advantage of them."

In a refreshingly frank statement, chairman Michael Cumming elucidated the theme. "There are numerous tenets of sound lending in our field, not least the need for adequate margins and sensible loan-to-value criteria", he said.

"For many years we have fought to maintain sensible rates and terms in the face of competitors seemingly intent on disregarding them. Happily, a greater degree of common sense is now prevailing which we hope will inure to our benefit for some time to come."

PCF's problem though, is that it too depends upon the big banks. It borrows in bulk from its main lenders Barclays Bank, RBS, Lloyds TSB and Singers Corporate Asset Finance before parceling out the money in thousands of small loans.

With competitors in the SME lending business including subsidiaries of the big banks themselves now out of the market, PCF would like to take advantage of the imbalance in supply and demand. But first it needs to find a new source of capital.

I shall be very surprised if it is unable to do so very soon. By supporting this form of business, financiers can take advantage of today's unprecedented margins between deposit and lending rates... and get brownie points for supporting small business.

You don't need to be an economics professor to see the attractions in that. I'm keeping an eye on this one.

This article was first published in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.

Follow Tom on Google+.