Motor finance: Is Close Brothers heading for a car crash?
Costs are mounting, loan books are shrinking, an existential motor finance ruling looms – is Close Brothers heading for disaster?
It’s been a bruising 12 months for the lender, with its stock down over 25 per cent.
Recent rallies have helped it claw back gains of over 65 per cent in the last six months to around 360p, but it still trades well below the highs of 548.50p achieved in the summer of 2024.
“Shares are beaten up,” RBC analysts said.
The troubles can be traced back to the group’s activity in the motor finance market.
As the firm delivered its third-quarter update on Wednesday, Panmure Liberum analysts said “the share price remains about something else, the outcome of the musing of the Supreme Court.”
Close Brothers took their fight to the highest court in the land in early April in a bid to overturn the Court of Appeal’s October ruling that it was unlawful for banks to pay a commission to a car dealer without the customer’s informed consent.
The bank tapped magic circle firm Slaughter and May for its legal showdown after trading out Leeds-based Walker Morris.
The decision to tag in the legal giant was no surprise, considering the lender’s historical exposure to motor finance. According to its half-year report, the market made up 20 per cent of its £2bn loan book.
The bank has set aside £165m in provisions.
Close Brothers’ stability under threat
In its third-quarter trading update released on Wednesday, the bank said it was still dealing with an “elevated level” of fees and expenses related to motor finance.
Net expenses hit £13.9m for the period, compared to £11.6m for the third-quarter of 2024.
Despite this, the group bolstered its Common Equity Tier 1 (CET1) ratio, a crucial indicator of a bank’s financial strength, to 14 per cent.
CET1 represents the highest quality capital a bank holds, consisting mainly of common shares and retained earnings. It serves as a buffer to absorb losses and maintain financial stability, ensuring the bank can meet regulatory requirements.
However, RBC analysis has warned that the Supreme Court’s ruling could significantly threaten the firm’s financial position.
Analysts project a 232 basis point hit to CET1 in a “base case” scenario – a blow which tops even the downside cases for its peers.
Should the ruling be negative, analysts predict the threat could balloon to 422 basis points for Close Brothers.
UK banks are expected to have a CET1 ratio of around nine per cent, which combines regulatory buffers laid out by the Prudential Regulation Authority.
A hit of over four per cent could put Close Brothers uncomfortably close to the edge of regulatory requirements.
Winterfloods swings to profit – just
After the October judgement, the bank “temporarily paused” motor finance activity but has since rebooted lending.
Close Brothers said there was an uptick in new business volumes for car financing in the third quarter.
However, reduced activity in its asset finance business and a competitive market in premium finance offset this, indicating that the lender’s woes are not isolated to the motor finance sector.
Its loan book decreased 0.9 per cent in the quarter to £9.7bn, down 3.5 per cent year-on-year.
Close Brothers’ net interest margin – a key metric for a bank’s profitability from lending – reduced to 7.1 per cent in the third-quarter, down from 7.3 per cent in the first half of the year.
The group’s Winterflood arm, which is an execution service provider that offers for retail traders, managed to swerve wider company woes and swing back into profitability.
The division secured an operating profit of £400m after benefiting from the market turbulence in April triggered by President Donald Trump’s erratic tariff agenda.
This was a swing from the £800m loss in the first half but a steep decline from the £1.7m in profit scored in the third-quarter of 2024.
Peel Hunt analysts Stephen Payne and Stuart Duncan said the “modest profitability” marked an improvement but came on the back of “volatile market conditions”.
But analysts said even “ignoring the motor finance provisions” return on equity was “depressed” and “well below the cost of equity.”