Close Brothers: hefty provisions for legal lending hit City bank

Far from the mark best describes an update from City investment bank Close Brothers on Friday.

A dearth of deal activity reduced operating profits at its small-cap brokerage Winterflood to just £1.7mn in the five months to December. Plans to set aside up to £90mn against bad loans at legal lending business Novitas were a bigger surprise. Shares fell as much as 13 per cent, approaching the 10-year lows hit in September last year.

The provisions are not a good look for a lender that prides itself on its ability to price niche risk. That is despite there being plenty of capital to absorb the hit and the improvements to earnings visibility that will arise from front-loading the pain.

Novitas was acquired in 2017 when Adrian Sainsbury, who became chief executive in 2020, was running the banking division. The lender’s risks are directly tied to the ability of lawyers to win cases. Assumptions about success rates have been consistently revised down. Payouts from insurers in the event of a loss have not delivered. Close Brothers will take at least one of these to court, raising the possibility that at least some of the hefty provisions will be written back in the future.

Assuming the full £90mn charge for Novitas is taken at its half-year results, the total provision would be £183mn or 75 per cent of the net book, which has been closed to new business since 2021. Consensus operating profits of £195mn this year would fall proportionately if that was the case. The hit would reduce the common equity tier one (CET1) capital ratio, which was 14.4 per cent at the end of December, by about 80bp.

Management’s CET1 target of between 12 and 13 per cent still leaves room to grow the dividend; £95mn was paid out last year. But a forward yield of 7.3 per cent suggests the market has doubts.

Sainsbury’s remuneration package irked investors in 2021. A flat payout for shareholders would be another cause of irritation.