Brokers Question CYBG’s Refreshed Targets

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UK banking enterprise CYBG has tweaked its earnings aspirations, which brokers expect will require double digit revenue growth as well as a lower cost base.

-Targets riding on advanced accreditation and expectations average mortgage risk will decrease
-May be able to return capital in the absence of acquisitions or ramp up of loan growth
-Loss of "passport" rights for London-based banks may result in softer economic conditions
 

By Eva Brocklehurst

The latest investor briefing from UK banking enterprise CYBG plc ((CYB)) provided refreshed guidance on several targets, which incorporate an assumption of 1-2% growth in the UK economy along with the current setting for zero official interest rates. Brokers ascertain the new aspirations will require double digit cumulative revenue growth as well as a lower cost base. Management now has a target of double digit returns on tangible equity (ROTE) by 2019 rather than 2020.

Macquarie struggles to envisage how this can be achieved without reductions to costs and a capital release. The broker's enthusiasm for the new outlook is also tested by the fact a material GBP200m pre-tax in restructuring charges is forecast for 2016-18, absorbing a not-insignificant amount of projected capital generation.

Macquarie believes the benefits of better medium term earnings are offset by the costs required to achieve the aspirations. The broker acknowledges the bank offers one of the best restructuring opportunities in European banking but considers the shares are well ahead of expectations. In the meantime, there are some risks around areas such as the pension deficit and the sustainability of hedge contributions.

Morgans considers the earnings outlook implied by the company at the time of the IPO earlier this year has now been downgraded. Moreover, cost cutting will not be enough on its own to achieve the targeted ROTE. This is now reliant on accreditation for the mortgage portfolio.

CYBG was planning previously to achieve the target without the assistance of Advanced Internal Ratings Based (AIRB) accreditation. Morgans describes this as a downgrade. The bank is expecting the accreditation before FY19, hence the bringing forward of the target, based on the expectation the average mortgage risk weight will decrease to 20% from 37%.

Another target has been lowered. The bank now aims for a cost-to-income ratio of 55-58% by FY19, having previously set it at less than 60% by FY20. Morgans takes a similar view to Macquarie. Restructuring costs outlined above will be needed to achieve this target. If accreditation is achieved and the average mortgage risk weight reduces to 20% then Morgans calculates that in the absence of an acquisition or significant ramp-up of loan growth, this would probably allow the bank to return capital to shareholders, subject to permission from the prudential regulator.

The broker is allowing for special dividends to be declared over the second half of FY18 and FY19 in its forecasts. Morgans reduces loan growth forecasts for FY17 and FY18 and increases the net interest margin forecast, while also reducing credit impairment charge forecasts. All up cash earnings per share forecasts have been raised by 10% for FY17 and 36% for FY18.

Yet Morgans remains cautious. Risks relating to Britain's exit of the European Union are still on the horizon. If London-based banks lose “passport” rights down the track then it is probably going to result in softening in economic conditions in London and may affect credit quality for CYBG.

Shaw and Partners is not so concerned and considers the story is about cost reductions and better cost management. The broker, not one of the eight monitored daily on the FNArena database, has a Buy rating and $5.30 target and considers the stock a good long-term proposition.

The trading update was overall positive, in Credit Suisse's opinion, with some conservatism in the revenue targets despite the expected earlier delivery of those targets. The broker considers the stock an inexpensive, self-help story and remains optimistic about the medium-term cost restructuring and enhancement of returns. The broker acknowledges, as with any turnaround, building up credentials takes time.

The apparent modest paring back of the retail lending target is sensible, in the broker's view, and growth in retail should be supported by the expectations in unsecured personal loans and improved mortgage retention.

The bank stated there would be no acquisitions in the early period post National Australia Bank's ((NAB)) spinning off of Clydesdale Bank and the IPO, and any acquisition subsequently would have to be highly accretive. Credit Suisse believes this reduces acquisition risk overall and, regardless, the existing multiples are not necessarily providing a particularly strong acquisition currency for any scrip-funded acquisitions.

Ord Minnett suspects the markets will be hesitant to readily accept some of the underlying assumptions made by the bank, in particular double digit revenue growth with flat net interest margin in 2017. The broker believes the stock's valuation already discounts the new ROTE target and risks are to the downside.

Bell Potter considers the outlook conservative. Cost cutting remains the key value lever, in the broker's view, and there is some strategic appeal in the stock. Bell Potter, not one of the eight stockbrokers monitored daily on the database, has a Buy rating and $5.45 target. The database has one Buy rating (Credit Suisse), two Hold and three Sell. The consensus target is $4.34, suggesting 1.3% downside to the last share price. Targets range from $3.62 (Morgan Stanley) to $5.25 (Credit Suisse).
 

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