Close Brothers Group plc

Good morning and welcome to the presentation of Close Brothers 2023 half year results. I'll start with a brief reflection on the key elements of our half one performance. Mike will then take us through the financials. I'll then come back to cover business performance and our strategy. At the end, you'll be able to ask questions either via the telephone conference line or over the webcast, which you can submit during or after the presentation. This has been a challenging six months, with a half-year result significantly impacted by Novitas and the UK economic outlook creating uncertainty for our customers. Although we continue to see good levels of loan demand and a resilient underlying credit performance, the volatile environment has been reflected in higher forward-looking provisions and challenging market conditions for CBAM and winter flood. Our first half results were impacted by a significant increase in provisions in relation to Novitas, resulting in a material reduction in operating profit. However, the underlying performance of our business has remained resilient. In banking, we saw 5% income growth with a strong net interest margin, and were particularly encouraged by the continued increase in new business volumes in our commercial business. In asset management, we generated net inflows of 6%, with a strong contribution from our new hires, although winter floods performance continued to be impacted by the slowdown in trading activity. We've maintained strong capital, funding and liquidity positions, with our C2 on capital ratio at 14%, remaining above the group's medium-term target range of 12% to 13%. We're also pleased to declare an interim dividend of 22.5 pence per share, reflecting the group's underlying performance and confidence in our business model. We've accelerated our efforts to resolve the issues surrounding Novatas loans with a focus on ensuring good customer outcomes. Let me briefly take you through the background on that business, our decision to wind it down and the financial impact on our half-won results. Novatas was the provider of finance for the legal sector we acquired in 2017. We decided to put this book in runoff and withdraw from the legal financing market in 2021. Some of the key attributes of our model have proven not to be evident in an overtasked business. We like businesses where, one, we have the in-house lending expertise, two, there's a track record of performance, and three, where there's underlying security of the loans. Cases were taking longer than expected to move through the courts, and when they did, there was a higher than anticipated failure rate and lower recoverability under the insurance policies. It became very clear that Novitas was not aligned with our close brothers model. We continue to evaluate our businesses and initiatives to ensure they are aligned with the key attributes of our model. And I'm confident there is no read across from Novitas to the other books in our portfolio. We've taken steps to resolve the Novitas situation. We've initiated legal action against one of the insurers relating to the recoverability of funds for failed cases. We took a £25 million provision in the first five months of the financial year, largely reflecting the expected longer timeframe for recovery for loans related to the litigation. As announced back in January, we've also now booked an additional £90 million provision, which assumes a material increase in the case failure rates and a cautious view on the assumptions for recoverability. This takes total provisions in relation to Novitas to £183 million and represents a 75% coverage ratio on the gross loan book of £245 million, leading us with a £62 million net loan book. We're confident this adequately reflects the remaining risk of credit losses. There's also expected to be an impact on income going forward from £36 million in full year 2022 to £8 million in full year 2024. While we're extremely disappointed with these developments and the impact they've had on our performance, we believe it's the right course of action to take and the financial strength of the group leaves us well placed to move forward with the delivery of our strategic priorities. I'll now hand over to Mike to take us through the financials and then I'll come back to talk about our business performance and strategy.

Thank you, Adrian, and good morning, everyone. Clearly this period's headline numbers have been materially impacted by the additional provisions taken against Novitas. This was the primary driver of the reduction in the adjusted operating profit to 13 million and the decline in adjusted EPS to 6.1 pence for the first half. Notwithstanding this significant impact, the underlying performance of the group has remained resilient. Income was up 1%, as 5% growth in the banking division offset reductions in the market-facing businesses. Costs increased 2%, as higher staff costs in banking and ongoing investment more than offset lower variable costs in asset management and winter flood. And on a pre-provision basis, profit was down 2% at £175 million. Excluding the P&L impact of Novitas, we generated a return on tangible equity of 12.5%. The Board has declared a 22.5 pence interim dividend, up 2% on last year. This reflects the underlying performance, confidence in our outlook, and our commitment to deliver sustained dividend growth. Moving on to the divisional performance. In banking, performance was significantly impacted by higher impairment charges in relation to Novitas, as well as forward-looking provisions reflecting weaker economic forecasts and a rise in arrears in motor finance. As a result, profit reduced 88% to $15 million. Profit in commercial increased 5%, excluding the impact of Novitas. Profits in both retail and property were down year-on-year. In asset management, we generated healthy net inflows, although profit reduced 41% to $9 million, as stable costs were more than offset by lower income. And winter floods performance was adversely impacted by the continued market-wide slowdown in trading activity and difficult market conditions, with profit down 73% to $2 million. Turning to the banking division, This period has seen a challenging market backdrop, creating significant uncertainty for our customers. Nevertheless, we have maintained our commitment to lending through the cycle whilst retaining our pricing discipline. As Novitas has had such an impact on the first half, I'll cover these numbers on an ex-Novitas basis to give you a better idea of our underlying performance. We saw 7% growth in income to £350 million, reflecting the strong margin and year-on-year loan book growth. And the net interest margin increased to 7.8%. Expenses rose by 9% to £182 million as we continued to progress our strategic investment programmes and incurred higher staff costs from inflation-related salary increases. On a pre-provision basis, profit rose 5% to £168 million. Impairment charges increased to £48 million, which corresponds to an annualised bad debt ratio of 1.1%. As a result, adjusted operating profit excluding novitas reduced 21% to £120 million. And the P&L impact of Novitas in the first half was a loss of 105 million, primarily driven by the impairment charges. Moving on to the loan book, which declined marginally in the first half, but grew 1% when excluding our businesses in runoff. Excluding Novitas, our commercial book grew 2%, with good demand in asset finance, more than offsetting a seasonal decline in invoice. This growth was achieved despite the impact of CBIL's lending running off. Our retail book contracted 1% when excluding the Irish motor finance business. The UK motor book was stable, although we saw a 2% decline in premium, reflecting first-half seasonality. Property grew 3% as we saw strong drawdowns from our healthy pipeline and repayment levels began to normalise. We are actively working to identify incremental and new opportunities in both our existing and adjacent markets. We are confident in the outlook for the loan book over both the short and medium term and remain well positioned to deliver disciplined growth. Now on to our net interest margin. Our specialist relationship-driven model and disciplined approach to pricing have enabled us to maintain a strong net interest margin. Excluding Novitas, we achieved a NIM of 7.8%. This reflects our pricing discipline on new lending and the optimisation of our liability mix in the rising rate environment. We also saw 14 basis points of one-off benefits from mark-to-market swaps. Looking forward, we are well positioned to maintain a strong net interest margin as we prioritise pricing over volume growth. However, we expect cost of funds will remain elevated in the next financial year. Moving on to costs in the banking division. There was a 5% increase overall as we progressed our investment programmes to support our strategic objectives and exercised rigorous cost control over our cost base. Business as usual costs increased to £148 million, driven by higher staff costs as we awarded salary increases in light of the inflationary environment. Investment costs rose to £35 million as we progressed our strategic programmes and initiatives. This also included £18 million of depreciation. We also incurred £4 million of costs relating to Novitas as we continued to wind down the business. As previously highlighted, we expect costs relating to our investment programs to stabilize over the next financial year, although related depreciation charges will continue to increase. And while our investment programs remain critical to support our banking high-touch model, we have intensified our focus on cost discipline and efficiency, especially in light of the recent inflationary pressures. We have initiated a number of strategic cost management actions, These, combined with our cost discipline, focus on creating capacity to accommodate growth, inflation and investment, whilst ensuring that we preserve our fundamental model attributes of service, expertise and relationships. We have commenced a multi-year technology transformation programme focused on strategic IT services and a programme simplifying our retail operations that will create efficiencies whilst delivering customer and control benefits. We also continue to evaluate additional opportunities for efficiency across the banking division with a view to delivering positive operating leverage over the medium term. Turning now to our credit performance, the annualised bad debt ratio was 3.6%, as we recognised 115 million of impairment charges in relation to Novitas. Excluding Novitas, the annualised bad debt ratio of 1.1% reflected weaker macroeconomic variables, particularly in the retail business, as well as a rise in arrears in motor, as our customers faced cost of living pressures. Notwithstanding this, we have not seen a significant impact on credit performance at this stage, with actual realised losses outside of Novitas equivalent to just £10 million in the period. Nevertheless, we continue to closely monitor the evolving impacts of the rising inflation and cost of living on our customers. we remain confident in our loan book, which is predominantly secured or structurally protected, prudently underwritten and diverse. Now, taking each of our banking businesses in turn, starting with commercial. The numbers in commercial were clearly significantly impacted by the impairment provisions in Novitas. So therefore, I'm going to run through the performance on an excluding Novitas basis to provide you with a view of the underlying performance. We saw strong income growth of 12% as continued good customer demand and higher new business volumes drove loan book growth and increased activity-driven income. Costs grew 11% from higher staff costs and investment spend on our asset transformation programme. As a result, pre-provision profit was up 14% as we achieved positive operating leverage in the business. Impairment charges rose 6 million to take into account the weaker external environment. And overall, profit was up 5%. Moving on to retail, where we saw income up 3%, driven by year-on-year loan book growth and our strong margin. The net interest margin rose to 8.2% in the first half as we adhered to our model of pricing discipline, passing through higher rates on new lending in motor finance. Costs were up 10% as we invested in the simplification program I talked about earlier, which will create efficiencies whilst delivering customer and control benefits, as well as higher staff costs, particularly in legal and compliance. We saw an increase in impairment charges. This was driven in part by the rise in arrears in motor, which is to be expected in the current environment and is in line with comparable industry trends, as well as by the weaker macroeconomic outlook. We remain comfortable with the quality of our portfolio, which is underpinned by our underwriting discipline and prudent level of provisions. Overall, profit reduced to £14.7 million. And finally, property, where strong drawdowns from our healthy pipeline and a normalising of repayment levels drove good loan book growth. Income was stable as we saw good levels of fee income and maintained a strong margin. Costs reduced by 9% as we maintained our strict cost discipline. And as a result, pre-provision profit was up 4%, reflecting the positive operating leverage in the business. We also saw a rise in impairment charges to reflect the weaker environment, particularly projected lower house prices. Overall, profit reduced to 33 million. Turning now to asset management. Managed assets increased 3% since the end of July to 15.7 billion, driven by positive net inflows, partly offset by negative market performance. Total client assets were up 2% to 16.9 billion. We delivered annualized net inflows of 6% with a strong contribution from new hires, despite ongoing uncertainty impacting investor sentiment. Operating income decreased 7% to 71 million, reflecting lower average AUM due to markets and lower client activity. The revenue margin decreased to 83 basis points, primarily due to flows into our lower margin investment management products. Expenses were stable at 62 million, with lower variable compensation offsetting higher staff costs and investment in new hires. As a result, adjusted operating profit decreased 41% to 9 million, and the operating margin decreased to 12%. And now on to winter flood. Income was down 21% to 39 million, driven by lower trading revenue, reflecting a market-wide slowdown in trading activity and a change in the mix of volumes. During the period, average daily bargains declined to 61,000 as low investor confidence and macroeconomic uncertainty impacted retail trading activity. And the significant decline in trading in our higher margin sectors is evident from the reduction in total number of bargains seen in both the AIM and small cap sectors. Nevertheless, diversification in trading sectors has helped to navigate the difficult market conditions, with fixed income benefiting from volatility in bond markets. And the growth in income from Winterblood Business Services continues to balance the cyclicality seen in the trading business. Costs reduced by 10% to £37 million, reflecting lower variable staff costs. As a result, operating profit declined 73% to £2 million. Winterflood has a strong market position, a long track record of trading profitably in a range of conditions, and remains well placed to take advantage of future trading opportunities when investor appetite returns. Moving on to our balance sheet, we maintained a strong balance sheet and continued to adopt our prudent approach to managing financial resources. Our total funding increased to £11.9 billion, well in excess of the loan book. We continued to borrow long and lend short, with the average maturity of allocated funding at 18 months, ahead of the loan book at 16 months. We managed liquidity conservatively, with our liquidity coverage ratio at over 1,000%. We have 2.1 billion of Treasury assets at the 31st of January, with the majority held with the Bank of England. We have a diverse funding base with an established presence across wholesale markets, along with our mix of retail and non-retail deposits. Although market rates increased materially in the period, we were able to mitigate this through actions taken to optimise our liability mix, resulting in an overall cost of funds of 2.6%. And as I mentioned previously, we expect our cost of funds to remain elevated in the next financial year. We increased our total deposit base to 7.3 billion and grew our retail book, which now makes up 49%. of all deposits. And our credit ratings remain strong, with Moody's rating Close Brothers Limited AA3, helping to support our ongoing issuance plans. Turning now to our strong capital position, looking at movements in the period, our transitional CET1 capital ratio was 14%, down from 14.6% at the 31st of July 2022. The movement mainly reflected the impact of Novitas on retained earnings and a decrease in risk-weighted assets. We maintained a significant buffer of 550 basis points headroom above our minimum regulatory requirement of 8.5%. Our leverage ratio remained strong at 12%. And on IRB, we continue to engage with the regulator and have submitted additional documentation as part of the Phase 2 process, although the timing remains under the direction of the PRA. And finally, turning to our capital framework, which articulates how we are thinking about excess capital. We are targeting a CET1 capital ratio range of 12% to 13% over the medium term, which will allow us to maintain a buffer to minimum regulatory requirements whilst also retaining flexibility for growth. Our primary objective is to deploy capital to support disciplined loan book growth in banking and to make the most of strategic growth opportunities. The Board remains committed to our dividend policy which aims to provide sustainable dividend growth year on year while maintaining a prudent level of dividend cover. And we will consider future capital distributions to shareholders in the absence of alternative growth opportunities. We remain committed to further optimising our capital structure, including the issuance of debt capital market securities, if appropriate. Thank you. And I will now hand back over to Adrian.

Thanks, Mike. I strongly believe that we have the right model to progress our strategy. We remain committed to our disciplined approach to lending through the cycle. This is reflected in our strong NIN, as well as in the underlying asset quality and performance of our loan book. Our specialist expertise and focus on service and relationships really differentiates us. This continues to be reflected in our customer satisfaction scores and high levels of repeat business. We have a distinctive culture at Close Brothers, a relentless customer focus and long-term approach to everything we do are embedded in our organisation. And I truly believe that this is one of the most important assets which is very hard to replicate. The strengths of our model have been evidenced through many cycles and are also reflected in our long-term dividend track record. As we move forward from Novitas, we're well positioned to progress our strategic priorities to protect, grow and sustain this valuable business model. We're focused on resuming our strong track record of earnings growth and returns by focusing on disciplined growth, cost efficiency and capital optimisation. We see investing through the cycle as key to protecting our model and enhancing its strengths. We view these programmes through two lenses. First, those focused on maximising our income generation, and second, those focused on resiliency and efficiency. We've seen our investment programmes deliver real benefits across the organisation, and I'll take you through two examples shortly. As Mike said earlier, it's also critical that we maintain cost discipline, especially in this inflationary environment. We have a number of strategic cost management initiatives. This includes rationalising our IT infrastructure and operational enhancements and simplification in our retail business. And we continue to evaluate additional opportunities for efficiency and remain committed to achieving positive operating leverage over the medium term. This intensified focus on cost discipline will create capacity for investment and support growth in our business. On the right-hand side of this slide, you can see this in practice. We've concluded our motor finance transformation programme, which enabled us to make the most of growth opportunities in the second-hand car market to enhance our digital capabilities and involve our dealer and customer proposition. We also continue to benefit from our customer deposit platform, which has enabled us to broaden our savings proposition. We've seen an 80% increase in our retail savings book since the launch of the platform. This has enabled us to optimise our funding mix and minimise the impact of higher interest rates on our cost of funding in half one. We're delivering on our strategic growth agenda and continue to actively evaluate potential opportunities that are aligned with our business model. In banking, we see a significant opportunity to broaden our sustainable finance offering as the UK heads towards a net zero carbon economy. At the four year, we set an initial green finance ambition to provide a billion pounds of funding for battery electric vehicles over the next five years. And in half one, we've lent over 90 million pounds. Our recently hired materials handling and agricultural equipment teams are executing deals and have built healthy pipelines. We've been piloting a specialist buy-to-let extension with our existing customers, which has proven successful, and see good prospects for this product. We continue to grow in the asset-based lending space, identifying syndication opportunities and partnering with other lenders. We've also hired a new team focused on providing bespoke term loan structures to SMEs requiring growth and investment finance. In asset management, we remain committed to building on our excellent track record of growing client assets organically through our successful hiring strategy, as well as through infill acquisitions. We also continue to see significant growth potential in winter flood business services. Assets under administration reach £12.4 billion, already exceeding our £10 billion target for this year, with a strong pipeline. Behaving responsibly is fundamental to our purpose, strategy and culture. As a signatory to the Net Zero Banking Alliance, we've committed to lowering our operational and financed emissions and have continued to develop our transition plans. CVAM has also made strong progress, becoming a signatory to the Net Zero Asset Managers Initiative. Over 40% of our company car fleet is now fully electric and, as I said earlier, we funded over £90 million of battery electric vehicles in the first half. We've also been focused on developing further our sustainability data and reporting. Our inclusion agenda is also very active, and we're running a number of initiatives focused on diversity, inclusion and social mobility. In summary, this has been a challenging six months, but I strongly believe that we have the right model to move positively into our next chapter. Last week's external events served as a good reminder of the benefits from our prudent approach to the management of our financial resources. Just to remind you, we run prudent levels of capital, funding and liquidity with a strong CET1 capital ratio. We borrow long and lend short and have a liquidity coverage ratio of over 1,000%. The strengths of our model have been evidenced through many cycles and remain unchanged. These include our long-term relationships, the deep expertise of our people, and our commitment to excellent customer service. I'm confident that our focus on delivering disciplined growth, cost efficiency, and capital optimisation will enable us to resume our strong track record of earnings growth and returns. Thank you, and we'd now like to open up for any questions you may have. And we'll start with a phone question.