Investing.com -- Moody’s Ratings has downgraded the long-term ratings and assessments of Close Brothers (F: CBRO ) Limited (CBL), Close Brothers Group plc (CBG), and Close Brothers Finance plc (CBF). The senior unsecured debt rating of CBG has been lowered to Baa1. The ratings and assessments of all these entities, including CBF’s backed Other Short Term ratings and CBL’s short-term deposit ratings, remain under review for potential further downgrades. This review was initiated on November 1, 2024.

In the same action, Moody’s affirmed CBL’s short-term Counterparty Risk Ratings and Counterparty Risk Assessment, as well as CBG’s short-term issuer rating.

The downgrade of CBL’s BCA to baa1 from a3 is attributed to the bank’s weakened solvency profile. This is due to higher costs, declining margins, and relatively low target capitalization levels, which result in lower loss absorption capacity against high credit risk of its loan portfolio.

In the first half of its fiscal 2025, which ended in January 2025, CBG recorded a pre-tax loss of £104 million. This loss was largely due to a £165 million provision for motor finance commissions and related operational and legal costs. After adjusting for these and other non-core items, the group’s operating profit dropped to £74.9 million from £88.1 million a year earlier.

CBG is also expecting its margins to compress further in the second half of its fiscal 2025 due to competitive pressures and reduced affordability of small and medium-sized enterprise borrowers in the high interest rate environment. The group’s growth has been constrained due to the need to preserve its risk-based capitalisation, to maintain a buffer against potential redress costs for motor finance commissions.

To mitigate the negative impact from sizeable provisions on its capitalisation, CBG undertook several capital management actions totaling approximately £360 million as of the end of January 2025. These included suspending dividends, selling the asset management business, reducing loan growth and cutting costs.

As of the end of January 2025, CBG’s Common Equity Tier 1 (CET1) ratio was 12.2%. After incorporating the impact of the sale of its asset management business, the ratio was 13.4% on a pro-forma basis. This was above its target level of 12%-13% and significantly higher than its minimum regulatory CET1 requirement of 9.7%.

The downgrade of CBG’s senior unsecured rating to Baa1 reflects the downgrade of CBL’s BCA to baa1, and moderate loss severity for this instrument under Moody’s Advanced Loss Given Failure analysis. The low probability of support from the UK Government also contributed to the downgrade, as it did not result in any rating uplift.

The ratings remain on review for further downgrade pending the outcome of CBL’s appeal of a court ruling related to a motor finance commission case to the UK’s Supreme Court. The hearing is scheduled for April 1-3, 2025, but the date of the expected judgment is unknown.

If the appeal is unsuccessful, it could lead to significant liabilities for the bank. The bank’s exposure to motor finance, which accounts for about 20% of its loan book, could lead to similar claims. The potential consumer compensation and related costs could be higher or lower than the £165 million provision the bank has set aside.

The uncertainty around the motor finance commissions review has led to extra costs for the bank, limited its growth, and may require other strategic actions to absorb potential compensation costs. As a result, Moody’s has lowered CBG’s governance issuer profile score to G-3 from G-2 under its environmental, social and governance framework.

Given that the ratings are on review for downgrade, positive rating pressure is unlikely. The ratings could be confirmed if potential redress costs are unlikely to significantly deplete the group’s capital. For the ratings to be confirmed, the bank will have to maintain ample liquidity in relation to its funding needs and also maintain its profitability and solid capitalisation and improve asset quality.

The bank’s deposit ratings and senior unsecured debt rating of CBG could also be downgraded due to a reduction in the volume of bail-in-able wholesale and institutional deposits and senior unsecured debt, which would increase their loss-given-failure.

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