Australia | Sep 09 2019
Negative factors continue to pile up for UK bank CYBG, amid unprecedented provisions for potential claimants in its FY19 accounts. Brokers rush to remove dividends from forecasts.
-Quantum of increase in complaints in August takes brokers by surprise
-Current share price implies a buying opportunity
-Yet many uncertainties remain including Brexit
By Eva Brocklehurst
The outlook for CYBG plc ((CYB)) has turned incrementally negative after the UK bank announced unprecedented claims provisions for payment protection insurance (PPI) in August.
CYBG has announced an additional GBP300-450m in provisions for these claims, which will impact statutory, not underlying, profit. CYBG has found it difficult to fully estimate the costs, as the main issue is the conversion rate for complaints that are subsequently upheld. The bank assumes a 5-12% conversion range for upheld complaints.
Hence, the final financial outcome could be much lower, or higher, but this is unknown. The bank expects to take several months to assess the quality of the information requests and the related financial impact and should be in a position to provide a more accurate estimate of costs at the FY19 results on November 28.
A ramp-up in complaints was expected but the quantum of the increase surprised Macquarie, which compares CYBG's top-up provision with Royal Bank of Scotland's announcement of a GBP600-900m increase, on a balance sheet that is nine times larger than CYBG.
Morgans calculates the top end of the provision range equates to a hit of 30p per share on an after-tax basis and, for every 5% of information requests that convert to an upheld complaint, the provision will increase by GBP100m. Morgans does not envisage a need for equity capital to be raised but remains mindful of the risk of hits to the CET1 ratio as well, from group legal action on fixed-rate tailored business loans.
The broker acknowledges some investors may take a view that the current share price provides an encouraging discount but highlights that a disorderly Brexit could have an impact on credit growth and asset quality. There is also the risk of further top ups to PPI provisions.
Dividend Impact Expected
Citi suspects the market is taking a worst-case scenario and these last-minute requests could be lower quality, and subsequently dismissed. Along with margin pressures and Brexit concerns the provisions have weighed on the stock, but the broker believes the current share price offers an attractive entry point, maintaining a Buy rating and reducing the target to GBP1.80.
The dividend is likely to be reduced or even cancelled but a capital raising is unlikely. A capital raising would be highly dilutive, the broker suggests, and slow down growth.
Macquarie considers CYBG's capital is vulnerable, and its position is no longer superior to larger peers, and removes a dividend in the second half from forecasts. Buybacks are also removed from forecasts. Moreover, the broker agrees a capital raising at current levels would be highly detrimental to shareholders and the bank is likely to look for alternatives.
Bell Potter is disappointed and includes a lower final dividend in FY19 estimates as a measure of conservativism, even though the pay-out ratio is for up to 50% of underlying earnings.
The broker lowers the price target to $2.20 and maintains a Hold rating. Despite a prospective price/earnings ratio of less than 5x Bell Potter does not think a Buy rating is warranted because of the numerous distractions for the company.
Even the most patient investors must be frustrated, Macquarie suggests, although the share price response appears excessive. The bank's capital position is weakened by -130-190 basis points, which is untimely given the Brexit crisis and the significant integration program with Virgin Money.
The company's self-help initiatives are considered the best of the UK banks, Citi acknowledges, with net interest margins being supported by a shift in the mix of asset & liability, and Bell Potter agrees the initiatives should underpin the stock in the long run.
Payment Protection Insurance
What is PPI? Payment Protection Insurance has been sold aggressively by British banks and mis-sold to millions over many years. This is a short-term income protection package sold alongside mortgages, loans and credit cards and designed to re-pay borrowings if the person become sick or unemployed.
The policies have been highly profitable and the Financial Services Authority began imposing fines for the improper sale of policies, banning single premium PPI in 2009, and recently bringing in a new regulations for the sale of these policies.
If the Bank of England attempts to stimulate the UK economy by lowering the bank rate or using unconventional measures than this could also have adverse consequences for net interest margins as well as the AUD/GBP exchange rate from the perspective of investors in ASX-listed CDIs (CHESS Depositary Interests), Morgans points out.
Nevertheless, risks are not all to the downside, which is why the broker retains a Hold rating. Avoiding any significant weakness in the UK economy means it is plausible that CYBG could generate a double-digit return on equity. The broker's target is $2.11, reduced from $3.16.
Macquarie currently forecasts a 10% return on equity by 2023 but recognises to achieve this level of return CYBG will need to execute on its strategy and macro conditions will need to improve.
Given a limited track record of generating organic capital, Macquarie also envisages a risk the regulator will impose higher capital buffers in the event of any issues with integration and any adverse Brexit outcome. The broker reduces its target by -25% to $3 and maintains an Outperform rating.
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