Join our community of smart investors

Strong and stable works for Close Brothers

The alternative lender is growing its loan book while maintaining a tight rein on its capital levels
June 8, 2017

With some commentators voicing concern about a potential downturn in the credit cycle, it may be time to cast a ballot for the 'strong and stable' candidate among the challenger banks: Close Brothers (CBG). Indeed, with a history dating back to 1878, Close has been around much longer than its Johnny-come-lately challenger-bank peers, and has also handled past downturns with much more panache than its mainstream rivals, which have, despite strong claims, often been found to be 'weak and wobbly' when the going gets tough.

IC TIP: Buy at 1,612p
Tip style
Growth
Risk rating
Medium
Timescale
Medium Term
Bull points
  • Growing loan book
  • Strong balance sheet
  • Healthy yield
  • Securities business recovering
Bear points
  • Premium to peers
  • Stock market volatility

With one of the lowest asset-to-equity leverage ratios in the sector, Close looks well placed to handle any trouble ahead, and in the meantime it is continuing to grow loans at a good clip while seeing a pick-up in its smaller securities and asset management divisions. What's more, the shares offer a good yield with the added attraction of an impressive five-year compound annual growth rate of 8.25 per cent.

During the six months to the end of January 2017, Close's core specialist banking business increased its adjusted operating profits by 13 per cent to £123m (84 per cent of the total) on the back of a 10 per cent rise in operating income. Retail finance, which comprises motor finance and premium finance, makes up the largest proportion of the bank's loan book, at £2.6bn at the end January. This grew 2.4 per cent in the six months. However, the fastest loan growth came from property finance, which increased loans by 3.3 per cent to £1.5bn. This business provides specialist residential development finance to professional developers. It does not have any exposure to the buy-to-let market and does not provide residential or commercial mortgages.

First-half banking profits also benefited from a greater proportion of funding being drawn from the Bank of England's term funding scheme. During the period, 76 per cent of loans came via this source, up from 67 per cent in the previous year, lowering the overall cost of funding.

At the same time as growing its loan book, the business has also managed to reduce its bad debts, down from 0.6 to just 0.5 per cent of total loans. The first-half expense-to-income ratio fell, too, to a healthy 49 per cent from 50 per cent. However, taking a prudent approach and focusing on stable net interest margins - a solid 8.2 per cent - meant more modest commercial and retail finance growth in the group's third quarter to April. Still, the total loan book was up 2.3 per cent in the three months, thanks to a stronger contribution from property finance.

Securities business Winterflood, which tends to see its business wax and wane with investor sentiment, is enjoying a turnaround in fortunes. As retail investor demand returned, it more than doubled operating profits to £14.4m during the first half of the year, which compared with a period when falling commodity prices hit securities trading activity. Winterflood's progress continued into the third quarter too.

The asset management division is also performing well, reporting continued growth in assets under management (AUM) and profits. During the first half operating profit was up 8 per cent to £9.1m, helped by net inflows of £125m. Profitability was nudged up by the sale of Close's OLIM Investment Managers business, although this also limited AUM growth. Again, further progress was evident in the third quarter, with managed assets up 7 per cent to £8.5bn. As a result, broker Shore Capital upgraded estimates for full-year managed assets by £0.5bn to £8.8bn. The benefit of this on profits is expected to accrue during the next financial year.

CLOSE BROTHERS (CBG)

ORD PRICE:1,612pMARKET VALUE:£2.44bn
TOUCH:1,611-1,612p12-MONTH HIGH:1,715pLOW: 975p
FORWARD DIVIDEND YIELD:3.8%FORWARD PE RATIO:12
NET ASSET VALUE:753pLEVERAGE:9

Year to 31 JulTotal income (£m)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
201462819410049.0
201567322511953.5
201668723412757.0
2017**76526513259.0
2018**81027513861.0
% change+6+4+5+3

Normal market size: 1,500

Matched bargain trading

Beta: 0.50

*Shore Capital forecasts, adjusted PTP and EPS figures