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Close Brothers offers prudent growth

The challenger bank has opted to protect margins, rather than chase market share
March 1, 2018

In a time when some market commentators have voiced concern about rising competition in some of the alternative lending markets, Close Brothers (CBG) stands out in having managed to generate growth while maintaining margins. With one of the lowest equity-to-assets leverage ratios in the sector, its prudent approach to lending may be one of the reasons that investors have got behind the stock in recent months. That’s not to mention the fact that all three of its core businesses were trading ahead of expectations during the first five months of its financial year.

1588p
Tip style
Growth
Risk rating
Medium
Timescale
Medium Term
Bull points

High potential yield

Low leverage

Solid lending growth

Protecting margins

Bear points

Competitive lending markets

Potential rise in funding costs

Close Brothers' track record has clear attractions. The company has never cut its dividend or launched a rescue rights issue and, according to broker Numis, it has achieved a 31-year compound annual EPS growth rate of 11 per cent. Meanwhile, when the credit crunch sank most of the banking sector, Close stood out in recording only a relatively modest fall in return on equity to a low of 13.2 per cent.

Close has already got off to a strong start in 2018. In a pre-close statement for the first half management reported a 7.3 per cent increase in its banking loan book compared with the previous year. What’s more, it said its net interest margin was stable, bad debts remained low and the underlying credit performance was consistent with the same time last year. Trading also remained solid at its Winterflood broking business, while its asset management division reported an 8.3 per cent increase in managed assets. News that all three businesses were trading ahead of expectations prompted earnings upgrades from analyst forecasts for this year, 2019 and 2020. Broker Shore Capital, for example, increased its forecast earnings for each of the three years by 4 per cent, along with a 2 per cent dividend upgrade.     

Close is building on progress made in 2017. Last year it grew its adjusted operating profits by 13 per cent to £265m, which was ahead of consensus expectations. Its banking division, which accounted for 92 per cent of adjusted operating profits, increased customer lending by 7 per cent to £6.9bn last year.

Property finance, which accounts for nearly two-fifths of the banking division, has led the way. It provides specialist residential development finance to established professional developers in the UK. London and the south-east represents around 70 per cent of the loan book, although it is expanding into other regions. As well as growing its loan book by 12 per cent to £1.6bn last year, the business is also delivering on all other key metrics, with extremely low impairments, an expense-to-income ratio of just 24 per cent and an increase in the net interest margin from 7.6 per cent to 7.7 per cent.

Its retail and commercial finance businesses have also posted solid loan book growth, at 8 per cent and 4 per cent respectively last year. Within retail finance, its premium finance segment – which provides credit to individuals for insurance policies – managed to offset lower growth in motor finance. It benefited from increased volumes of business via brokers and premium inflation. There’s been a similar trend within its commercial finance business, with invoice finance loan growth offsetting a flat loan book in asset finance.

Given the lender’s exposure to the increasingly competitive asset and motor finance markets, it has been prioritising margins over market share growth. Still net interest margins nudged slightly lower at the retail and commercial finance businesses shifting the overall banking net interest margin down from 8.2 per cent to 8.1 per cent last year. While impairment losses did creep up from £37.9m to £40.2m, this still looks very healthy, accounting for less than 1 per cent of the average loan book.

Part of the reason lenders have been able to compete so competitively on margin is due to the Bank of England’s Term Funding Scheme, which allows lenders to borrow from the central bank at the base rate. The scheme closed in February, meaning the group’s cost of funding could increase slightly. However, just 5 per cent of its total funding comes via the Funding for Lending and the Term Funding Schemes, putting Close in a competitive position.

CLOSE BROTHERS (CBG)   
ORD PRICE:1,588pMARKET VALUE:£2.4bn
TOUCH:1587-1589p12-MONTH HIGH:1,715pLOW: 1,315p
FORWARD DIVIDEND YIELD:4.1%FORWARD PE RATIO:11
NET ASSET VALUE:817pLEVERAGE:8.7
Year to 31 JulTotal income (£m)Pre-tax profit (£m)*Earnings per share (p)*Dividend per share (p)
201567322511953.5
201668723412757.0
201776526513160.0
2018*80827713863.0
2019*85628814465.0
% change+6+4+4+3
Normal market size:1,500   
Matched bargain trading    
Beta:0.51   
*Shore Capital forecasts, adjusted PTP and EPS figures