Financial group CYBG plc ((CYB)), or the UK’s Clydesdale Bank, provided many elements to its strategy briefing, targeting a higher mix of both personal and business lending and higher future net interest margins. Macquarie believes, if the bank can deliver on its goals, there is scope to close the valuation gap with large UK bank peers.
An effort will be made to exploit a sizeable, albeit under-utilised customer base through enhanced products and services. Capital remains strong and achieving medium-term targets is expected to result in a return on equity of over 12%. There is a high degree of self-help in the initiatives, which include -GBP$200m in net cost reductions by FY22.
Revenue will be driven by a shift in asset and liability mix rather than outright growth, which is expected to support net interest margins. Profitability will be prioritised over growth, and the bank is targeting system growth for mortgages while aiming to grow business and unsecured lending at above-system levels.
Shaw and Partners takes issue with these expectations derived from the change in asset mix. Currently, mortgages represent 84% of the loan portfolio, business loans 10% and unsecured personal lending 6%.
The plan over the medium term is to grow unsecured personal loans to represent 10% of the portfolio at the end of three years. Business loans are expected to grow to represent 15%. Achieving these targets requires a 26% increase in unsecured personal loans and 22% increase in business loans and, on the broker’s calculations, these are considered “more than optimistic”.
Citi is happy with a strategy that is based on a strong brand, self-help and considers the new FY22 targets achievable. There is enough detail to make the broker confident in its Buy rating. Still, only small upgrades are expected to estimates as lower costs are offset by lower revenues. Morgans also suspects the tailwinds from strong growth in low-cost deposits will be largely offset by intense competition in the mortgage market.
Shaw and Partners asserts that the achievement of a return of 12% would be remarkable, in view of the historical and near-term forecast performance of the business. The broker considers it peculiar there was no income growth targeted through FY19-22, despite the high growth rates expected for assets and funding. The only conclusion the broker draws is that net interest margin declines are likely to be significant.
The broker, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Sell rating and $3.20 target. The database has two Buy ratings (Citi, Macquarie) and one Hold (Morgans). Macquarie has a target of $5.30 and Morgans, $3.57.
Investors have always been concerned that the benefits from the bank’s re-vamp will be long-dated and Citi acknowledges a margin of safety is needed as margins are likely to remain under pressure, given strong UK banking competition. The broker suspects it is too early to give CYBG full credit for cost delivery and low provisions. Nevertheless, the improving return profile overall makes the bank attractive on a medium-term view.
Bell Potter considers the detailed disclosures provide a classic cost reduction story, amid plenty of capital and the resilience to ride out volatile market conditions. The broker, not one of the eight, has a Buy rating and $4.10 target.
More Targets
Management is now targeting a cost-to-income ratio in the mid 40% region by 2022. This is important, in Macquarie’s calculations, as asset growth was not specifically targeted and, based on the expected transition in the loan mix, implied growth rates appear unrealistic. Macquarie calculates that a cost-to-income ratio of 45% would deliver 2022 earnings broadly in line with current estimates.
The broker notes the target for the CET1 ratio of 13% is below the first half level of 14.5% and, together with annual capital generation of over 100 basis points by 2022, may allow for share buybacks in the future in addition to dividends. Dividends are expected to rise as the pay-out ratio increases to around 50%.
The broker finds the total capital return potential attractive, noting the potential for capital returns over and above ordinary dividends by 2022 was explicitly referenced by management. However, Morgans expects subdued revenue growth over the medium term and considers special dividends or share buybacks are unlikely.
Virgin Money
CYBG intends to re-brand to Virgin Money and take advantage of the wider recognition of the name, connecting with a wider global audience for Virgin companies. Surveys suggest there is higher customer affinity for the Virgin brand and it also attracts a more affluent customer.
Following the acquisition of Virgin Money, the bank now has the scale to compete nationally. Macquarie notes a disruptive strategy is planned and the business should be positioned between the large UK banks and the challenger banks.
CYBG expects to offer customers a different form of loyalty scheme rather than only one with simple monetary rewards. The funding mix will be changed to attract lower-cost relationship balances and use them to replace the relatively more expensive Virgin Money retail savings deposits.
