CYBG (ASX:CYB) lists on the ASX today and hundreds of thousands of NAB shareholders will receive one CYB Chess Depositary Interest for every four NAB shares in an unwanted UK regional bank. What should they do?
On February 8, NAB (National Australia Bank) will finally exit the UK after 29 years when the demerger of CYBG plc (Clydesdale & Yorkshire Banking Group) is implemented. NAB acquired Clydesdale in 1987 and Yorkshire Bank in 1990. Both UK banks have seriously dragged on NAB’s shareholder returns for many years.
The answer depends on the investor’s time horizon and dividend needs. In short, CYB is cheap if management can improve profitability by cutting costs and growing the loan book, but this will be a journey of several years and everything else needs to go well. Australian investors who need fully franked dividends will consider selling all their CYB shares as a small inaugural dividend will not be paid until late 2017, at the earliest and CYB dividends will never be franked because all the bank’s earnings are taxed in the UK.
The upside for patient investors is attractive. Compared with major Australian banks, CYB is extremely cost-inefficient and profitability as measured by return on equity is very poor at just 5%. But return on equity can double to around 10% by 2020 if management executes well on its productivity and lending growth plans and the UK economy grows.
If all goes well, CYB is cheap. The institutional bookbuild this week for the 25% of CYB shares sold by NAB, as opposed to the 75% given away to shareholders, arrived at a price of £1.80 but book value per share is north of £3.10. The deep discount despite solid demand for the stock reflects NAB’s strong motivation to be rid of CYB as soon as possible.
The business has been static over the last four years, probably due to the dead hand of NAB’s ownership and a focus on recapitalisation and survival. Now CYB is independent, management will have to become more active if the business is to grow. In our view the plan to grow by increasing lending to home owners and small to medium businesses is achievable.
It’s important to flag one downside risk is further provisions to compensate customers affected by the mis-selling of ‘payment protection insurance’, a chronic and serious misconduct issue affecting the profitability of most UK retail banks. In August last year CYB booked a further £390m of provisions for the 2015 financial year after a total of £670m of provisions for the three previous years. The bottom-line loss after provisions worsened over the last two years. The bullish case is CYB has overprovided to prepare the business for IPO and writebacks of provisions boost ROE towards management’s target sooner.
If all goes well the stock can easily double by 2020 and NAB will be accused of giving CYB away cheaply. If payment protection provisions mount or the UK economy and property market descend into stagnation or deflation, NAB will look good for exiting the UK after a period of economic growth and property price inflation.
One final observation is the likely overhang in the stock as disinterested investors exit over the year ahead. Most of CYB’s initial shareholders will be NAB shareholders who received CYB shares through the demerger. Foreign reporting formats, the relative lack of transparency of a foreign bank compared with familiar Australian banks and the lack of any dividend will all be deterrents, as will the limited access to CYB’s UK-based management. These could dampen the share price.
This aversion could make the stock cheaper still. We find CYB an interesting investment proposition and we are watching and waiting.
 
Other recent reports and research notes on CYB can be viewed here.

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The following article has been republished or referred to by The Australian Financial Review, The Age & Business Spectator.