NAB And Clydesdale: What Should Shareholders Do?

This story features NATIONAL AUSTRALIA BANK LIMITED. For more info SHARE ANALYSIS: NAB

-UK outlook modestly supportive
-NAB needs to renew domestically
-Will Oz investors want Clydesdale?
 

By Eva Brocklehurst

National Australia Bank ((NAB)) has moved ahead with its plans for the de-merger of UK-based Clydesdale Bank. The bank has released an investor presentation, with background information, to prepare for its exit by the end of the year.

The bank intends to offer shareholders 70-80% of the UK business as part of the de-merger. The remainder will be offered to institutional investors in an initial public offering of shares. Clydesdale will be a mid-sized UK bank, with a 2.0% market share of UK mortgages, and expects to be in a strong position to increase that market share. Management is of the belief that an independent Clydesdale will drive better outcomes for shareholders. Indeed, Deutsche Bank observes the UK macro outlook appears to support reasonable growth, with unemployment expected to decline and house price inflation continue. Official interest rates are forecast to rise in early 2016.

The broker does note competition appears to be increasing, given several listings in the small to mid tier segment over the last year. Moreover, management was understandably reluctant to provide forward-looking guidance on the outlook. On the negative side, there will be headwinds from higher capital requirements and investment in digital technology and branches. The positives are that low-margin mortgages and non-core SME portfolios are being run off and rates are likely to rise next year. Above-system growth is expected to deliver operational efficiencies but Deutsche Bank does not expect Clydesdale will reach the returns of its larger peers, given lack of scale.

The disclosure provided little that was new and Goldman Sachs remains of the view that the UK divestment is the most significant of NAB's optimisation initiatives. Ultimately, the broker suspects the de-merger would result in a valuation increase for NAB that is only 1-5% higher than the current share price. Hence, management needs to demonstrate it can reinvigorate the domestic business, particularly business banking. Investors also need to believe that the new-look entity has a cost of equity that is below that of its Australian peers.Goldman Sachs, not reflected in the FNArena database, retains a Neutral rating on NAB and $35.05 target.

Morgans welcomes the divestment, arguing Clydesdale has been a drag on group returns. The broker does acknowledge the significant work done to turn Clydesdale around. Nevertheless, a significant re-rating for NAB will only come from evidence of a turn around in the Australian banking franchise and the broker believes this is a development with an 18 months to 2-year time frame. In terms of Clydesdale as a stand-alone entity, it could offer significant leverage to a UK recovery but the effort to improve earnings will be a challenge and the broker also questions whether Australian investors would have the desire to hold a UK-listed vehicle.

Clydesdale Bank's loan portfolio has been gradually moving towards mortgages and small-medium enterprise loans. Mortgages made up 69% of the loan balance in the first half, with business at 26% and retail unsecured loans at 4.0%. The growth in the mortgage book has largely been driven by strong exposure to intermediaries. Its funding base is mainly customer deposits, which account for 65% of the funding base. The bank's CET1 capital levels have been rising as the regulatory environment changes. Clydesdale intends to focus on niche segments in SMEs and strengthen its offering to omni-channel users.

 FNArena's database has two Buy and six Hold ratings for NAB. The consensus target is $35.85, suggesting 5.4% upside to the last share price. The dividend yield on FY15 and FY16 estimates is 5.8% and 5.9% respectively. 
 

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