The prospect of higher SME loan defaults has prompted Fitch Ratings, a provider of global credit ratings, to take “rating action” on Close Brothers, among several other mid-sized UK banking groups and providers of asset finance. 

The London-based rating agency said the action taken reflected the downside risks triggered by the coronavirus pandemic, which during March has left an indelible mark on the UK banking and financial services sector.

Katherine Long, an associate retail banking analyst with GlobalData, said even against this backdrop Close Brothers remained in good health.  

Long said the rating action by Fitch Ratings on the various banking groups – in particular Paragon Bank, Close Brothers and Investec – “reflects the banks’ higher exposure to sectors that are likely to be badly affected by the Covid-19 crisis: SME lending, BTL mortgage lending, senior debt for development and niche lending such as aviation.”

She added: “As the crisis could precipitate higher levels of loan default in these sectors, bank assets that seemed safe a few months ago suddenly appear riskier but overall, those banks appear in good health.”

The news comes as Fitch Ratings estimated GDP growth in the UK could fall by close to 4% in 2020, “followed by a sharp recovery in 2021”.

Underlying this growth expectation is “the assumption that containment measures will be unwound in the second-half of 2020, with material downside risk to these economic forecasts,” the group said in a statement. 

On the upside, Fitch said the policy adopted by the UK government and the Bank of England to support the private sector with monetary and fiscal measures were positive for the banking sector. 

Despite this, the rating company said it expected banking asset quality “to weaken compared with previous expectations and earnings to come under pressure from lower business volumes, higher loan impairment charges and pressure on net interest margins.”

Close Brothers

Fitch said the fallout from the pandemic “has heightened risks to Close Brothers Group given its above-average exposure to SME lending through asset and invoice finance, to retail customers potentially affected by employment disruptions in motor finance, and to property lending that will suffer delays in completion and sales.”

It said the ratings of Close Brothers Group and Close Brothers Limited “reflect a strong record of performance through economic cycles, which has historically compensated their appetite for higher-risk lending” but added that in the current crisis, “we expect pressure on earnings through rising credit impairments and lower volumes.” 

Financial highlights

Close Brothers Group’ banking division operates in the retail, commercial and property spaces, as well as being active in the asset management and securities sectors.  

For the last available figures, the adjusted operating profit for the Group’s entire banking division was £253.7m, for the year ending 31 July 2019, up 1% on the previous year. 

Close Brother’s commercial business lends principally to SMEs both through its direct sales force and broker network and is composed of its asset finance and invoice and speciality finance business.

The adjusted operating profit for its commercial business was £86.5m in 2019 (up from £76.1m in 2018), according to its financial statement. 

The asset finance business has about 27,000 customers. It has a loan book of £1.9bn, with an average loan size of £40,000, with an average loan maturity of three to five years. 

Its invoice and speciality finance business work with around 2,300 SME operators in the UK (including a big role for the financing for legal businesses and breweries).

Its loan book is valued at £1bn, with an average loan size of £400,000, with an average loan maturity of two to three months, according to its financial statement. 

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Below is an excerpt from Fitch on its key rating drivers for Close Brothers

Fitch said the rating actions include upgrades, downgrades and affirmations of several issuer and issue ratings, which were placed on under criteria observation (UCO) following the publication of Fitch’s new rating criteria on 28 February 2020. The affected ratings have been removed from UCO. 

Fitch has downgraded the Long-Term IDR and VR of Close Brothers Group (CBG) and of its banking subsidiary, Close Brothers Limited (CBL) to ‘A-‘/’a-‘ from ‘A’/’a’ as a result of the economic fallout of the pandemic. The Outlooks on the ‘A-‘ Long-Term IDRs are Negative.

The ratings of CBG and CBL reflect a strong record of performance through economic cycles, which has historically compensated their appetite for higher-risk lending. 

In the current crisis, we expect pressure on earnings through rising credit impairments and lower volumes, which will no longer be commensurate with an ‘a’ VR. 

CBG’s pre-provision profit can absorb higher loan impairment charges typically over 4% of gross loans (including the pre-provision contributions of its asset management and securities businesses), so it is likely that the group will maintain profitability, albeit at depressed levels. 

Capitalisation was solid with a 13.4% CET1 and 11.3% leverage ratio at end-January 2020.

Fitch has downgraded CBG’s senior debt rating ‘BBB+’ from ‘A’ and removed it from UCO. CBG’s senior debt is anchored to the Long-Term IDR and downgraded by a notch to reflect below-average recovery prospects. 

In line with Fitch’s new Bank Rating Criteria this reflects our expectations that buffers of holding company senior and group junior debt will remain below 10% of risk-weighted assets (RWA).

The rating of Tier 2 debt issued by CBG has been downgraded to ‘BBB’ from ‘A-‘ and removed from UCO. 

This debt is anchored to CBG’s VR and its notching has been widened to reflect the change in baseline notching for loss-severity to two notches (from one previously) from the VR.

Senior debt issued by Close Brothers Finance plc has been downgraded to ‘A-‘ from ‘A’, in line with the group’s Long-Term IDR.

The group entities’ Short-Term IDRs and debt ratings are downgraded to ‘F2’ from ‘F1’, which correspond to the ‘A-‘ Long-Term IDR and debt ratings and CBG’s ‘bbb+’ funding and liquidity score.