Close Brothers plans to bolster capital position by hundreds of millions in response to FCA motor finance probe

Close Brothers has outlined measures that could boost its capital position by around £400m in response to potential compensation costs tied to a Financial Conduct Authority (FCA) review into historic unfair car loans.

The news sent the merchant banking group’s shares up 14 per cent on Tuesday morning.

Close Brothers’ stock is still down 52 per cent since the FCA announced in January that it would review now-banned discretionary commission arrangements for car loans after claims that consumers were unfairly charged high-interest rates.

The group’s shares cratered 23 per cent in one day last month after it announced it would scrap its 2024 dividend and place its 2025 dividend under review due to uncertainty over the probe’s potential impact.

It reiterated on Tuesday that it would not immediately make a provision for the review, with chief executive Adrian Sainsbury saying: “The FCA’s review of the motor finance industry is ongoing and it would be premature to predict the outcome or estimate the potential impact on the group. The board however recognises the paramount importance of preparing the group for a range of outcomes from this review.”

As well as scrapping this year’s dividend, Close Brothers said on Tuesday that it had identified actions to boost its common equity tier 1 capital by around £400m by the end of the 2025 financial year, including optimising its risk-weighted assets, further cost-saving measures and retention of £100m in earnings.

It said: “The board is confident that these decisive actions will position the group well to withstand a range of scenarios and potential outcomes.”

Analysts have estimated that auto lenders could be on the hook for as much as £16bn in compensation costs. Close Brothers is estimated to have the biggest relative exposure of any bank at up to £350m, according to RBC, with the figure nearly 70 per cent of its current market capitalisation as of Monday’s close.

Auto lending made up around a fifth of Close Brothers’ loan book at £1.95bn as of last July. Its motor finance arm provided roughly 100,000 car loans last year and has more than 5,000 dealer partners.

Adding further pressure, the FCA confirmed in a letter to the Treasury Committee in January that it was looking at the premium finance sector – which makes up around 10 per cent of Close Brothers’ loan book.

Close Brothers on Tuesday reported a statutory pretax profit of £93.8m in the six months to 31 January 2024, up from £11.7m for the same period the previous year – this figure was £116.6m, excluding the impact of provisions tied to its legal finance business Novitas.

It saw operating income fall one per cent year-on-year at £470.8m, which the group said reflected growth in banking and Close Brothers Asset Management offset by the performance of its market-making business Winterflood and higher expenses.

Close Brothers said market conditions “remained unfavourable” for Winterflood, which saw income rise 24 per cent to £7.8m and assets under administration (AuA) increase 11 per cent to £13.8bn. The group said the division was “placed to retain our leading market position and benefit when investor appetite returns”, expecting AuA to reach more than £20bn by 2026.

The group’s banking division saw loan book growth of 4 per cent to £9.9bn, while its net interest margin narrowed slightly to 7.5 per cent from 8.0 per cent.

Close Brothers’ adjusted operating expenses rose 12 per cent to £334.7m, which it pinned on higher staff costs and continued investment in banking.

The group said it had “mobilised additional cost management initiatives which are expected to generate annualised savings of c.£20 million by the 2026 financial year, partly offsetting the adverse impact on the group’s income as a result of the management actions”.

RBC Capital Markets analyst Benjamin Toms said in a note: “Whilst we believe the review of motor finance is already baked into the shares, no further FCA comment until September 2024 and premium finance also being in the regulator’s cross-hairs lead us to see little short-term upside.”

Updated with shares and analyst commentary