Traditional merits of Close Brothers

Not so long ago, Close Brothers - one of the last remaining traditional British merchant banks - looked an uninspiring prospect. It had acquired a reputation for being excessively cautious and producing relatively low growth - hardly ideal characteristics in the boom before 2008's financial meltdown. In today's more austere times, however, Close's cautious reputation isn't such a drawback. Moreover, Close appears to have emerged from the financial crisis in decent health.

Consider its banking operation, which focuses on niche areas, such as property and retail motor finance. At a time when conventional lenders have seen loan demand collapse, bad debts soar and earnings evaporate, Close's banking division is bounding ahead. In 2009-10, its loan book expanded 23 per cent to £2.9bn, while the division's operating profit grew 47 per cent to £79.5m. As a result, the division generated 55 per cent of group profits. Helped significantly by further good performance from the banking division, broker Numis securities expects Close's earnings, adjusted for various exceptional items, to rise 10 per cent to 67.2p in the current year to end-July 2010 and then surge to 86.5p in 2011-12.

Bad debts are under control, too. The banking unit's impairment losses as a percentage of its average loan book dropped to just 2.4 per cent in 2009-10, compared with 2.6 per cent a year earlier. And, when other lenders have been forced to turn to shareholders or the government to shore up their capital resources, Close's capital position has remained robust. At the full-year stage, its regulatory core tier-one capital - essentially shareholders' funds - was 13.9 per cent of risk-weighted assets; even the well-capitalised banking giant HSBC only managed a ratio of 9.9 per cent.

But Close also boasts a solidly performing securities business. That comprises UK market maker Winterflood and Frankfurt-based broker-dealer Seydler. The division also includes the group's 49.9 per cent stake in Mako, a market maker in equities, fixed income and commodity derivatives. Winterflood grew operating profit 3 per cent in 2009-10 on the back of a 10 per cent hike in volumes, while Seydler saw operating profit rise from £1.5m to £4.9m in that period. Decent performance has continued into the first quarter, too. Close's trading update this month reported that Winterflood had grown income per bargain, while Seydler is being buoyed by increased capital market activity.

However, Mako has struggled with falling volumes as trading conditions have become less volatile and its underlying operating profit fell 63 per cent in 2009-10 to £8.2m. What's more, Close's asset management arm made a small loss in the first quarter of 2010-11 after reporting an operating profit of just £3.3m in 2009-10, down from £12m a year earlier. Even though funds under management grew 15 per cent to £8.5bn in the three months to end-October, the business has been hit by reorganisation costs as management looks to refocus the operation on wealthy UK private clients and smaller savings institutions.

Still, a prospective dividend yield of nearly 5 per cent, based on Numis Securities' estimated payout for 2011, is certainly attractive, especially given the absence of payouts from most conventional lenders. Moreover, it's quite conceivable that Close will eventually be taken over. It has long been mooted as a bid target, with Cenkos, Blackstone, Tata and Japanese group Orix having been rumoured as possible suitors. Longer term, it's easy to imagine that Close will go the same way as so many other British merchant banks and be taken over by a bigger firm.