Close Brothers leans on the tripod

Close Brothers’ (CBG) multi-decade track record of unbroken dividend increases may have ended last year, but with the help of its tripod-like business model, the group appears to have emerged from the pandemic on the front foot in 2021.

Interim figures for the six months to January came in ahead of market expectations, powered by a knock-out performance from market making arm Winterflood Securities. The division, which provides execution services to brokers, wealth managers and large investors, posted a 223 per cent rise in operating income to £34.2m, as a doubling in fees from surging trading volumes outstripped a 71 per cent hike in overheads.

That resulted in a 69.3 per cent return in opening equity, outstripping the steady-as-she-goes asset management division, where a slight contraction in margins and initial advice fees produced a still-respectable 32.5 per cent return.

Given the choice, however, chief executive Adrian Sainsbury sees the best use of capital in the growth of Close’s loan book. Despite further falls in property and premium retail lending, the period ended with loans up 4.2 per cent to £8.17bn, driven in large part by the bank’s participation in the UK’s Coronavirus Business Interruption Loan Scheme (CBILS).

Though this has led to some cannibalisation in SME lending opportunities, government loan guarantees mean the £730m in CBILS credit Close has extended to date is largely risk-free.

This doesn’t mean the bank believes wider credit risks have abated, however. “We don’t think the challenges for SMEs and consumers have actually played out yet,” cautioned Sainsbury, as Close increased its impairment charges in the period to £52.8m, from £36.7m in the first half of FY2020. In turn, this lifted provision coverage from 3 to 3.3 per cent of outstanding loans, though the bad debt ratio has fallen markedly from last summer’s peak.

Close’s diversified model and sector-leading net interest margin of 7.5 per cent make for tricky comparisons with larger peers. At first glance, an 88 per cent premium to forward tangible book value looks expensive, though this is broadly in-line with the five-year average. During this time, the relative strength of the dividend has also meant the shares have delivered 8.8 per cent a year on a total return basis, in excess of the FTSE All-Share.

Even if investors assume a moderation in trading activity at Winterflood, the banking division’s first-half 15.7 per cent return on tangible equity signals that group-wide earnings growth is achievable. Analysts at Peel Hunt believe upgrades to consensus 2021 earnings forecasts of 114p a share could soon follow. Buy.

Last IC View: Buy, 993p, 22 Sep 2020