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The share prices of FTSE 250 companies aren’t supposed to go down by over a fifth in 60 minutes.
But that’s exactly what happened on Friday (25 October) when the Court of Appeal ruled that Close Brothers Group (LSE:CBG) owed a “duty of loyalty” to its customers when selling motor finance.
Although the ruling isn’t related to the ongoing investigation by the Financial Conduct Authority (FCA) into the alleged lack of transparency over commission payments to dealers, the company’s concerned that the judgement could influence the outcome.
Unusual
Significant share price movements are relatively uncommon in the second tier of the UK’s listed companies. Larger businesses generally experience fewer surprises which leads to greater stability.
However, Friday’s events prove that nothing’s guaranteed when it comes to investing. The stock closed the day 24.5% lower. It’s now fallen 64%, since the FCA started its work.
Looking to the future
However, in my opinion, successful investing is about taking a long-term view. Although I’ll be the first to admit that not everyone shares this belief, ‘short-termism’ (as illustrated by last week’s rapid sell-off) can work to the advantage of those that look further ahead.
That’s because the dramatic fall in the Close Brothers share price could be an opportunity for me to buy into a quality company at a bargain price.
I accept there’s going to be a period of uncertainty. The financial implications of the Court’s ruling need to be fully understood. Indeed, the company said in its statement: “We will be temporarily pausing the writing of new UK motor finance business while we review and implement any relevant changes to our documentation and processes to ensure compliance with these new requirements”.
However, I’m reasonably optimistic that next month, in 2025, and for several years to come, Close Brothers will be profitably selling car finance and other financial products. Yes, it’ll have to improve the transparency surrounding its commission payments. But I believe it’ll continue to make money from people wanting to buy cars.
Implications
And even if the FCA ruling requires compensation to be paid to legacy customers, the payments will be treated as exceptional items. This means they’ll be reported separately from its ongoing business. Listed companies are generally valued on their underlying (excluding one-off items) earnings per share.
Of course, any payouts will be in cash. And I’ve seen estimates that the investigation could cost the industry up to £16bn. It’s believed that Close Brothers has a 20% market share.
So — in a worst-case scenario — it could face a bill of £3.2bn. But nobody really knows.
Decision time
And that’s a big problem for me, which is why I don’t want to buy.
At 31 July, the company had £14bn of assets on its balance sheet. This includes £1.58bn of cash. During its 2024 financial year, it generated £314m of cash from its trading activities. Compensation of £3.2bn equates to twice its current bank balance, or 10 years of inflows.
Although I believe the company has the financial firepower to withstand even the most negative of outcomes from the FCA review, it will cause some damage. And at this stage, it’s impossible to fully understand the implications. Therefore, an investment today would be a little too risky for me.