Financials Unshackled Issue 6: UK & Irish Updates - and Close Brothers In Focus

Note kicks off with a quick review of key UK & Ireland developments followed by a deep dive on CBG's FY24 results, key points from the S&U trading update and Together's FY24 results

The material below does NOT constitute investment research or advice - please scroll to the end of this publication for the full Disclaimer

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Background to this note

The main focus of this note is on the key take-aways from - as well as some perspectives on - the Close Brothers Group (CBG) FY24 results (for the 12 months to 31st July 2024) following the publication of this morning’s update and the investor / analyst call that took place at 09:30 BST. However, I kick off first with a few soundbites on a couple of other key UK developments (FCA soundings on cash savings market and BoE rate decision take-aways) as well as a couple of key developments in an Irish context (SME and large enterprise credit and deposit statistics for 2Q and the state of the political parties according to a fresh opinion poll). I wrap up with a short synopsis of: i) S&U plc’s (SUS) unscheduled trading update from this afternoon; and ii) the non-bank lender Together Financial Services’ full year results for the year to 30th June 2024 (which were published this morning). A more detailed update on the week’s developments - and a ‘look ahead’ to next week will be provided in a ‘Weekly Banking Update’ which will hit your inboxes at the end of the week.

Firstly, a few key UK & Irish soundbites

UK (1): FCA update on cash savings market

The FCA published its update on the UK cash savings market yesterday, noting that the average interest rate paid on easy access savings accounts rose by 45bps to 2.11% in the 11 months to June 2024 from 1.66% in July 2023 when the FCA published its initial review (together with a 14-point action plan to ensure banks and building societies pass on interest rate increases to savers appropriately). I have read some of the media reports on the FCA update, which have, broadly, emphasised that the FCA is effectively stepping up its pressure on the banks to offer more attractive deposit rates. However, my own sense, from digesting the FCA materials, is that does not appear to be the case. Indeed, studying the language in the FCA documentation published yesterday, suggests to me that the FCA appears to be broadly satisfied with the outcome from a savers’ perspective following its aforementioned July 2023 published review and, if anything, pressure is likely to level off a bit from here (albeit a watchful eye will remain on developments with that said). Specifically, I would point out the following: i) the FCA points out that UK savers are c.£4bn better off as a result of the improved rates on easy access product since the publication of its July 2023 review (thereby validating its own intervention); ii) the FCA continues “to encourage savers to shop around” - nothing surprising in this statement and one would expect the FCA to say this; and iii) the FCA notes: “As the base rate has started to fall, this has impacted the interest rates offered. We will continue to closely monitor firms’ future savings rate changes. However, we expect that our interventions to improve competition and support better communications will continue to have a positive impact…While we will continue to monitor the savings market, we do not anticipate providing further savings updates unless we identify market-wide concerns in the future”. This last comment smells to me like a slight softening of pressures (given the good outcomes observed to date and in recognition of the falling official rate backdrop) rather than a ‘step-up’ in scrutiny on the part of the watchdog. With that said, the FCA shall clearly remain focused on the matter and the sector remains ‘on guard’ (especially in relation to the speed and extent of passthrough rates as official rates reduce). For what it’s worth I don’t anticipate any further near-term pressure from the Treasury Select Committee (TSC) either - notably, NS&I recently reduced rates across a whole series of its bond products (something which will also have been noted by the FCA) and I suspect a ‘quid pro quo’ for higher bank taxes (which appears likely in the upcoming Budget) is less scrutiny of savings rates.

UK (2): BoE MPC maintains bank base rate at 5.0%

The BoE Monetary Policy Committee (MPC) voted by a majority of 8:1 at its meeting yesterday to maintain the bank base rate (BBR) at 5.0% (the decision was published at 12:00 BST today), which has not come as a surprise to the market. It is worth noting the following statement within the Monetary Policy Summary: “In the absence of material developments, a gradual approach to removing policy restraint remains appropriate. Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. The Committee continues to monitor closely the risks of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting.”, signposting a cautious approach to rate easing in overall terms. Indeed, the Meeting Minutes noted that: “The degree of restrictiveness of monetary policy might be less than embodied in the Committee’s latest assessment, meaning that monetary policy would have to remain tighter for longer”. However, it would appear that a November rate cut is firmly on the agenda now (unless interim economic data surprises) with acknowledgment amongst the MPC members that wage and price-setting have continued to normalise (albeit there is a range of views amongst the members on the degree to which underlying domestic inflationary pressures will continue to unwind).

Ireland (1): Trends in SME and Large Enterprise Credit and Deposits

The Central Bank of Ireland (CBI) published its quarterly ‘Trends in SME and Large Enterprise Credit and Deposits’ for 2Q24 this morning at 11:00 BST. The key findings to highlight are:

• Increase in weighted average interest rate on SME drawdowns: The weighted average interest rate on new SME drawdowns (gross advances €1bn in the quarter, +17% y/y) was 5.49% at the end of June, +10bps q/q.

• Reduced weighted average interest rate on SME loan stock: The weighted average interest rate on outstanding SME loans (€18.2bn at end-2Q24, up marginally q/q - owing to net lending +€169m in the quarter, which was broadly flat q/q) printed at 5.22% at the end of June, -7bps q/q - marking the first quarterly reduction since 2021. Given the increase in the weighted average rate on drawdowns in the quarter the CBI assesses that the lower average rate on loan stock is likely to be due to repayments of amounts drawn down in a higher rate environment, which seems a logical conclusion.

• Net lending to all Irish resident private sector enterprises expands again q/q in 2Q: Net lending to all Irish resident private sector enterprises was +€546m q/q in 2Q24 (following an increase of €369m q/q in 1Q24) - marking the largest quarterly increase since 2Q23, albeit the y/y change was a decline of almost €2bn (less than the c.€5bn y/y decline recorded at end-2Q23)

• Irish resident private sector enterprise deposits in growth mode again: 2Q24 saw deposit inflows of €3.4bn from all Irish resident private sector enterprises, reversing the reduction observed in 1Q24. Deposit flows from this particular segment of the market tend to bounce around quite a bit - for example, +€2bn in 4Q23 and then -€2.7bn in 1Q24.

Ireland (2): Repeat of current coalition Government looking increasingly likely; speculation mounting in relation to 2024 General Election date

Some further positive newsflow for those who desire political stability in an Irish economic (and, in my view, an Irish banking policy) context early this morning with The Irish Times publishing the findings of the latest Irish Times/Ipsos opinion poll on the state of the political parties. Fine Gael was +4pps to 27% since the last poll in early Summer, Fianna Fail was -1pp to 19%, while Sinn Fein was -3pps to 20%. This is the highest level of support that Fine Gael (with its party leader, Taoiseach Simon Harris’ own approval rating shooting up by 17pps to 55%) has registered since June 2021 and, from a Sinn Fein perspective, it is the lowest level of support that party has achieved since the last General Election in 2020. Pat Leahy, a highly experienced political commentator, penned a separate opinion piece in The Irish Times this morning noting that today’s findings “will prompt renewed discussion about a pre-Christmas election, and significantly increased internal political pressure for that to happen”. For anyone looking to keep abreast of Irish politics I highly recommend tuning in to the regular Inside Politics podcast hosted by Hugh Linehan of The Irish Times (link below; it’s an easy listen and is always highly informative).

https://www.irishtimes.com/podcasts/inside-politics/

Close Brothers FY24 Results - Deep Dive

Close Brothers Group (CBG) published its preliminary results document and associated slide deck for the 12-month period to 31st July 2024 (FY24) this morning at 07:00 BST, which was followed by an analyst / investor call at 09:30 BST in which I participated. A separate RNS was also published at 07:00 BST to announce the agreed disposal of CBG’s Asset Management (CBAM) division. Note that any references made to consensus estimates in this piece relate to the company-compiled consensus data of 18th September 2024, which is published on the company’s website.

Results Document here: https://www.closebrothers.com/system/files/rrp/press/CBG%20FY%2024%20Results%2019.09.2024.pdf

Slide Deck here: https://www.closebrothers.com/system/files/rrp/presentations/CBG%20FY24%20results%20presentation%2019.09.24.pdf

CBAM disposal RNS here: https://www.closebrothers.com/system/files/rrp/press/Close%20Brothers%20agrees%20sale%20of%20CBAM%20to%20Oaktree%2019.09.2024.pdf

Overall Take:

Solid financial performance delivered in FY24, with a 4.4% operating profit before tax (PBT) beat. However, guidance for flat Cost/Income in FY25 will drive some marginal downgrades (more costs than income) with a risk that consensus impairment losses drift slightly higher as well. Some concerns around what the final redress costs will look like in relation to the FCA’s ongoing motor finance commissions probe given: i) the price fetched on the sale of CBAM to Oaktree; ii) the scale of the capital-strengthening actions in train, including in relation to implications for FY25 dividend capability (albeit many don’t expect a FY25 dividend anyway); and iii) given increased complaints and enquiries, which appear to be driving up associated costs. On a separate but interrelated note, the cautious tone of management didn’t come as unexpected in my view. However, it feels like sell-side analyst expectations for the associated FY25 financial impact will rise materially further upon next model revisions.

Review of the Key Messages:

Operating PBT beat: CBG posted adjusted operating profit of £170.6m, broadly in line with consensus expectations for £170m - but operating profit before tax of £142.0m was a touch higher than consensus for £136m, indicating an overall earnings beat of the order of 4.4% (we understand that different approaches were taken by the sell-side analyst community in relation to certain one-off costs meaning the operating PBT number is the most relevant one to focus on).

Capital-strengthening actions underway (more detail below): Given the particular focus on capital strength ahead of the outcome of the FCA review into historical motor finance commissions (expected in May 2025), it’s worth zoning in on this upfront. The transitional CET1 capital ratio printed at 12.8% (fully loaded: 12.7%). While this was -20bps h/h, CBG announced this morning the agreed sale of its Asset Management division (CBAM) to Oaktree for a total equity value of £200m, including £28m of deferred consideration in the form of preference shares (so, upfront cash proceeds of c.£172m). This transaction is intended to close early in the 2025 calendar year and is expected to drive c.100bps of CET1 capital ratio accretion on completion.

Loan growth biased towards higher-RWA density lending segments: Net loans of £10.1bn (+2.1% h/h) were broadly in line (+0.6%) with consensus expectations for £10.0bn. However, on closer examination, while all three lending divisions observed net loan growth in 2H24, the growth has been concentrated in higher RWA-density divisions (with high risk-weighted Property lending seeing the fastest growth) which is more capital-intensive (and it was noted by the CFO on the call that, while theoretically, the decision to taper lending appetite in a bid to conserve capital until the outcome of the FCA review is known should favour higher risk-adjusted margin lending, it does not work like that in practice with some NIM compression observed in the commercial book, which is growing at a faster clip than the Motor Finance book, for instance). Separately, deposits of £8.7bn were +5.2% h/h and CBG continues to benefit from an ultra-strong LCR.

Financial performance throws up no great surprises: 1) Operating income of £944.2m (+1% y/y, with h/h growth of 0.6% in 2H24) was marginally below consensus expectations for £951m, with Banking NIM coming in at 7.4% within that (consistent with the 7.4% YTD NIM reported at the stage of the 3Q24 trading update, albeit 2H24 NIM was 7.2%). 2) Adjusted operating expenses of £674.8m (+10% y/y, with h/h growth of 1.6% in 2H24) were below consensus expectations for £686m. There were £28.6m of separate one-off costs booked ‘below the line’ versus consensus expectations for £33m. 3) Notably, Banking adjusted operating profit was -9.3% y/y to £205.6m excluding Novitas (although the prior year figure was also bumped up by fair value gains on derivative instruments). 4) Impairment losses of £98.8m (£41.7m in 1H; £57.1m in 2H) were marginally ahead of consensus expectations for £96.0m and CBG notes that it has not seen a significant impact on credit performance owing to inflation and cost of living challenges. 5) The above culminated in a reported RoTE of 8.3%, down from 10.1% for 1H24.

Dividends: CBG notes that the reinstatement of dividends in FY25 and beyond will be reviewed once the FCA has concluded its review and any financial consequences for the group have been assessed. The CFO was clear on the call that, if the outcome of the FCA review becomes known in May 2025 (on schedule), it may take time, subsequently, to understand the financial implications so it could possibly be into FY26 before a decision is made in this respect. Nothing surprising in that but more below on this topic.

Guidance a bit disappointing:

Outlook Synopsis: 1) Low single-digit growth net loan growth guided for FY25, consistent with consensus expectations for +1.8% y/y growth. 2) Guided that 7.2% 2H24 NIM print will be sustained in FY25, arguably slightly below consensus expectations for 7.3%. 3) No change to guidance for expected annualised cost savings of c.£20m p.a. from FY26 (full run rate expected to be achieved by end-FY25) from the previously announced additional cost management initiatives. 4) Guiding stable Cost/Income ratio for FY25, which is a nudge worse than consensus expectations for a c.40bps y/y reduction in Cost/Income in FY25. 5) Guiding bad debt ratio to remain below long-term average of 1.2% in FY25 (1.0% in FY24; 0.9% in 1H24), which is suggestive of modest impairment losses inflation - indicating some adverse changes to consensus numbers (consensus expectations are for broadly flat impairment losses in FY25) are likely. Stage 3 loans inflation (+24% y/y; +13% h/h) also of note here although the CFO put paid to any material concerns in that respect on the call. 6) No changes to CBAM or Winterflood guidance. 7) Management is guiding: i) £55-60m net expenses in central functions in FY25 (well ahead of consensus expectations for £35m but the divergence largely (though not wholly) appears to be because consensus has treated some of these items as ‘Adjusting’ items, ‘above the line’) reflecting an elevated level of professional fees and expenses associated with the FCA review as well as some income diminution owing to downward official rate movements; and ii) adjusting expense items of £15-25m (£10-15m associated with complaints handling and other operational costs related to the FCA review; £5-10m of further restructuring costs). Consensus expectations are for £124m of adjusting expense items in FY25 (with a massive variation in estimates), which appear largely related to expectations for a customer redress provision post-FCA review rather than substantive incremental administrative costs - so, even if analysts were to leave redress costs estimates unchanged (more below on this), I would expect some inflation in FY25 adjusting expense items estimates.

Why I think the outlook is a little disappointing relative to consensus expectations: i) arguably, marginally lower Banking NIM guidance versus consensus (especially given a SRT transaction is ‘waiting in the wings’ and the ensuing associated negative NII drag is not embedded in guidance, understandably) and a sceptical analyst question on the call around confidence in NIM guidance more broadly; ii) most importantly, costs: the costs picture is convoluted (given underlying expenses, ‘above the line’ adjusting items, and ‘below the line’ (other) one-off items) but, when you get your head around it, it appears that CBG is guiding: a) slightly higher administrative costs related to the FCA review versus what had been expected by consensus; and b) higher u/l expenses (consensus was expecting a c.40bps reduction in Cost/Income for FY25 and it appears that the flat Cost/Income guidance is slightly more attributable to costs than income (relative to consensus expectations) though it is difficult to be entirely definitive on that point); and iii) possibility that consensus expectations for impairment losses tick up a little bit (although one point to note is that the CFO affirmed management’s confidence in Novitas provisioning on the call and acknowledged the possibility of writebacks in due course). However, it’s the FCA review and associated implications that are in most focus.

Fleshing a few points out in some more detail:

Capital-strengthening actions / FY25 dividend implications: CBG has not provisioned for any potential redress costs associated with the FCA’s review of motor finance commission arrangements. To recap, CBG announced a range of management actions that have the potential to augment CET1 capital by c.£400m by end-FY25. Updating on progress in this vein (notably, the results document states that “…we have the potential to increase the group’s CET1 capital ratio to between 14% and 15% at the end of the 2025 financial year…”), CBG notes: i) £100m CET1 capital enhancement owing to FY24 dividend foregone; ii) RWA optimisation (selective loan growth, partnerships, risk transfers related to Motor Finance business (with one now prepared)) could further augment CET1 capital by a further £100m; iii) run rate annualised cost savings of £20m p.a. by end-FY25; iv) potential other actions including securitisations, etc. - within this ‘bucket’ CBG has today announced the agreed disposal of CBAM, which is expected to boost CET1 by £100m; and v) a further prospective £100m CET1 top-up if the FY25 dividend is foregone. Everyone is ‘in the dark’ in relation to what the outcome of the FCA investigation will be. Totting up the above (prior to taking into account the prospect of further capital management actions like securitisations) gets you to, roughly, £420m. While one can hardly say that today’s update brings any greater clarity in relation to what the outcome of the FCA review will be (though the detail in the results document does note that CBG has seen a further increase in enquiries and complaints since the January 2024 FCA announcement) and what that will mean for a FY25 dividend, it does feel like the market is becoming more jittery around the overall redress costs that CBG could face and whether any dividend is realistic for FY25 (especially given some concerns in the market today to the effect that the deal struck to sell CBAM to Oaktree yielded lower-than-expected sale proceeds - despite the transaction completing at 27x earnings). I see the mean analyst estimate for the FY25 dividend is 21.0p per share (range is 0.0-40.0p) and I suspect that will come down materially further on the back of today’s update as it appears that management is ‘pulling out all the stops’ to ensure it will have ample CET1 capital to cope with the FCA review outcome in mind - and it appears the market is, understandably, reading the collective actions and messages as representative of increased fears that things could be worse than first thought (a sort of psychological inevitability anyway in the absence of unexpected ‘good news’ as D-Day comes closer I would argue).

IRB accreditation process “a very slow burn”: CBG has moved, in more recent times, to de-emphasise the prospective benefits that it could generate upon receipt of IRB accreditation (to be clear, what I mean by this is that it has become less of a prominent point in the regular updates). This is because, like for peer banks, the approval process has been extremely slow (indeed, Martin Stewart’s speech at the BBA conference in March 2017 seems a very distant memory now: https://www.bankofengland.co.uk/-/media/boe/files/speech/2017/harrowing-the-ploughed-field-refining-the-standardised-capital-regime.pdf). No mention of IRB in the results document (which I think is telling) although the slide deck does flag that “Engagement with regulator on IRB continues”. Given that the initial IRB application was submitted as far back as December 2020 and it was noted in September 2023 that CBG has successfully moved to Phase 2 of the process I asked the CFO on the call whether we could get any more clarity on outstanding workstreams or estimated expected timing of an outcome. Morgan understandably wouldn’t be drawn on specifics, noting that it’s “a very slow burn”. The outcome is out of CBG’s control and it seems sensible to relegate the prominence of the topic until we get closer to a result. The broader specialist bank / challenger bank community have been very disappointed by the length of time it is taking to get anywhere close to ‘levelling the playing field’ in this respect.

Reaffirmation that CEO is on temporary medical leave: As per the RNS on Monday 16th September, it was reaffirmed that Adrian Sainsbury has taken a temporary medical leave of absence. While the CFO, unsurprisingly, adeptly handled the earnings call by himself, it goes without saying that hopefully Sainsbury will be back in action soon.

S&U Trading Update - Key Points

S&U plc (SUS), the specialist motor and property finance lender, published an unscheduled trading update, revising its expectations for the FY24 financial year (year to 31st January 2025). Following a cautionary update on 12th August last, SUS has now downgraded FY24 PBT expectations noting that Group profits in 1H24 (the six months to 31st July 2024) are expected to be c.£12.8m (SUS will publish interim results on 8th October) and “…this is likely to cause the Group's financial year profitability to 31 January 2025 to fall below market expectations”. Notably, Edison is forecasting PBT of £29.0m for FY24. The downgrade is pinned on the impact that the imposition of the FCA’s Section 166 notice is continuing to have on Advantage Finance, the group’s motor finance division (the largest by far of its two divisions).

Notably, today’s update states that the Group anticipates improvements in Advantage’s performance in 2H24 on the back of a plan that it intends to implement upon the anticipated removal of the FCA’s restrictions and appropriate modifications as a result. However, the company issues a caveat noting that timing remains uncertain.

On a brighter note, SUS reaffirms that Aspen Bridging (its - smaller - property lending division) continues to churn out strong and profitable growth “driven by robust business momentum and excellent credit quality” and reaffirms that the outlook for the division remains positive with a healthy deal pipeline in situ.

Together Financial Services FY24 Results - Stellar performance despite tough market conditions

Together Financial Services (Together), the non-bank specialist lender (focused on BTL, bridging, commercial term, residential, and development lending) published its results for the full year-ended 30th June 2024 (FY23) this morning. I didn’t get to dial into the results call at 14:00 BST, but here are the key take-aways from the results:

1. Net loans +14.9% y/y to £7.4bn, reflecting strong loan originations of £3.0bn (at a weighted average LTV of 59.0%, -2pps y/y) in the year. Together’s Annual Report calls out the following key points in relation to its lending markets: i) Tough conditions in UK BTL (as has been well-documented) with landlord profitability under pressure owing to near-record house prices and increased borrowing costs; ii) continued strong growth in bridging lending; iii) some shrinkage in specialist commercial term lending activity which is expected to continue in the short to medium-term; iv) challenging conditions in the non-standard first-charge residential mortgage lending markets owing to higher interest rates; and v) some reduction in the size of the development finance market but, lending opportunities emanate from the government housebuilding targets and the retrenchment of the high-street lenders from this category of lending. Reads negatively on the trends but Together has still managed to churn out healthy mid-teens growth in net loans (it achieved growth in three of its five lending divisions with the residential mortgage lending and the development finance books flat y/y)!

2. Borrowings of £6.5bn at year-end, implying a gearing ratio of 83.9% (+1.0pp y/y). The funding mix was further strengthened in FY23, with a total of £3.2bn of facilities raised / refinanced in the year.

3. Shareholders’ funds of £1.16bn at year-end, +£41m y/y.

4. NII of £369.3m for FY23 (+22.7% y/y) with NIM printing at 5.4% (5.2% in FY22).

5. Widening jaws with operating costs +15.0% y/y to £116.1m - which saw the Cost/income ratio reduce by 160bps y/y to a keen 31.9%.

6. Slight increase in CoR to 79bps (+6bps y/y) with impairment charges printing at £54.1m (+£11.7m y/y).

7. Underlying PBT of £200.9m, +22.8% y/y.

8. Reported RoE of 13.2%, up from 12.3% in the prior year.

A name worth keeping a close eye on. A declining official rate backdrop will ultimately support NIM expansion in my view (I have been tracking Together for years and the company historically printed materially higher NIMs than it does today, albeit it has seen some margin accretion of late as the lag in passthrough rates resolves itself). The new CEO Richard Rowntree will undoubtedly have ideas in the context of the evolution of the business and, while the affable founder Henry Moser (who is the ultimate controlling shareholder) will likely still make his views known, the next few years will likely bring some kind of change (indeed, a possible public market listing has been debated for years - but the perennial CEO succession question was unanswered until earlier this month), which will be interesting to monitor.

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