Close Brothers bolsters capital ratios before landmark motor finance judgment

Close Brothers' total capital ratio increased by 80 basis points to 18% in the last quarter, with its CET1 ratio at 14%, exceeding regulatory minimums, as the bank prepares for a potential adverse ruling concerning motor finance commissions that could result in significant payouts. The bank and FirstRand are challenging a Court of Appeal judgment that could force them and other lenders to compensate motor loan customers; Close Brothers has already set aside £165 million to cover potential claims. CEO Mike Morgan stated the company is taking proactive steps to ensure strong, sustainable returns once the motor finance uncertainty is resolved, while KBW analysts noted the improved capital position mitigates the risk of a capital raise.

Analysis

Close Brothers (CBRO.L) reported a significant strengthening of its capital base in the quarter ending April, with its total capital ratio increasing by 80 basis points to 18% and its Common Equity Tier 1 (CET1) ratio reaching 14%. These figures comfortably exceed the respective regulatory minimums of 13.7% and 9.7%. The bank anticipates its CET1 ratio will surpass its medium-term target range of 12% to 13% by the financial year-end. This capital enhancement is a proactive measure as Close Brothers, alongside FirstRand (FSRJ.J), contests a Court of Appeal judgment concerning motor finance commissions, which could mandate substantial redress payments to customers across the UK banking sector. Close Brothers has provisioned £165 million for potential claims, while other institutions like Lloyds Banking Group have set aside significantly larger sums, such as £1.15 billion. Analysts at KBW estimate Close Brothers' 'worst case' liability at £460 million and believe the improved capital position mitigates the risk of a capital raise. Despite these capital improvements and CEO Mike Morgan's commitment to sustainable returns and a more efficient business, underscored by planned annualised cost savings of £25 million by FY2025, the company's shares have declined 57% year-to-date, reflecting ongoing investor concern over the legal uncertainty. The broader market sentiment is neutral but cautious regarding this situation.

Key Decisions for Investors

• Investors should closely monitor the outcome of the Court of Appeal judgment on motor finance commissions, as this represents the most significant near-term catalyst and risk factor for Close Brothers.
• Evaluate whether the current £165 million provision, combined with the strengthened capital ratios, adequately covers the potential financial impact, especially considering KBW's 'worst case' liability estimate of £460 million.
• Consider the substantial year-to-date share price decline in the context of the improved capital position and ongoing cost-saving initiatives, assessing the risk-reward profile pending resolution of the legal overhang.