Close Brothers still taking higher impairments

In a rising rate environment, specialist lenders have much to fear from rising debt provisions linked with macroeconomic uncertainty, which has a way of chipping away at higher interest income before investors see the benefit. This is largely why full-service specialist lender and broker Close Brothers (CBG) has endured a long and painful decline in its share price, with none of the interest rate honeymoon enjoyed by the high street banks last year. In fact, there is little sign that cost pressures will ease for Close Brothers before 2025.

Management confirmed that depressing outlook, with the operational results amply confirming why the market has been downgrading the bank. Unfortunately, there is much that the bank cannot control when it comes to the macro conditions that affect its lending.

The indifferent economic situation meant that Close had to made £87.2mn of additional loan impairment charges, which may be reversed if the economy improves. Overall bad loan provisions doubled to £204mn during the year, or 0.9 per cent of its book, with the likelihood that these won’t change back any time soon.

Meanwhile, another year of poor performance at Close Brothers’ Winterflood broking business – operating profits here were down another 75 per cent to £3.5mn on a dearth of deals that shows no sign of breaking – it is clear why the results had an air of depression. This was further reinforced by Novitas, Close Brothers’ abortive legal lending arm, which despite being in run-off still cost the group £115mn in impairments as cases that have no realistic course through the courts are dropped.

Management's own forecast is that cost growth is likely to return in line with revenue increases only in 2025. Currently, cost rises for this year are expected to be in the 8-10 per cent range, mainly because of increased salary awards. The net interest margin was stable at 7.6 per cent, which is also expected for this year.

Broker Peel Hunt forecasts that Close Brothers’ will enjoy some stabilisation this year because of an increase in loan growth and forecasts a price/earnings ratio of 7.5 for 2024. That is broadly in line with the rest of the banking sector, currently, but whether this represents true value is open to question, particularly when impairments are considered. Hold.

Last IC View: Hold, 971p, 14 Mar 2023