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Fitch Affirms CYBG and Clydesdale Bank at 'BBB+'; Outlook Stable
September 7, 2017 / 3:40 PM / in 2 months

Fitch Affirms CYBG and Clydesdale Bank at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, September 07 (Fitch) Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) of Clydesdale Bank Plc and its parent CYBG PLC, at 'BBB+' with Stable Outlooks. Fitch has also affirmed the entities' Viability Ratings (VR) at 'bbb+'. In addition, Fitch has assigned a 'BBB+(dcr)' Derivative Counterparty Rating (DCR) to Clydesdale Bank as part of its roll-out of DCRs to significant derivative counterparties in western Europe and the US. DCRs are issuer ratings and express Fitch's view of banks' relative vulnerability to default under derivative contracts with third-party, non-government counterparties. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS IDRS, VR, DCR AND SENIOR DEBT CYBG's and CB's IDRs and VRs reflect the group's strong balance sheet, with healthy asset quality, showing very low levels of impairments, combined with healthy liquidity and sound capitalisation. However, profitability is still very low and is likely to remain under pressure from the low base rates prevailing in the UK, and by an improving but still high cost base. CYBG has reported full-year losses since 2012, mostly the result of legacy conduct charges and more recently, restructuring costs. The bank reported a profit of GBP30 million for the six months to end-March 2017, and we expect profitability to improve as legacy and restructuring costs decline. However, margin pressure will likely continue, given the bank's undiversified revenue stream and deleveraging of most of its higher risk-higher return business. Targeted annual loan growth in the mid-single digit loan growth should support revenues, but the bank's ability to grow further is sensitive to changes in the economic outlook for the UK. Costs remain high but efficiency is improving thanks to cost-cutting measures, including branch closures and headcount reductions, and increased digitalisation. Separation projects are ongoing following the demerger of CB from its previous owner, National Australia Bank Ltd (NAB; AA-/Stable) in February 2016, and restructuring costs have declined but are likely to be significant over the next 12 months. However, we expect that associated risks will be manageable for the bank and as it progresses with these investments, it is possible that its regulatory capital requirements will also fall. CYBG has been able to develop its retail deposit franchise and its loans/customer deposits ratio has improved (end-March 2017: 114% per Fitch calculations), with customer deposits forming 78% of end-March 2017 funding (excluding derivatives). The bank has also demonstrated its ability to access wholesale funding following its separation from NAB as a standalone entity, including via secured and unsecured issuance over the past year. On-balance sheet liquidity is maintained at adequate levels, with liquid assets comprising mainly cash and high-quality sovereign exposures. This is complemented by good access to contingency liquidity sources. Asset quality is healthy with low levels of arrears. The proportion of defaulted loans (defined as IFRS impaired loans plus loans which are over 90 days past due) was 1.2% at end-March 2017. Impaired loans were a low 0.7% of gross loans at the same date. However, the bank has some sector concentrations, including loans to the agriculture industry, which accounted for 23% of SME lending at end-March 2017. We consider that these loans could be particularly sensitive to ongoing Brexit negotiations. CYBG's capitalisation is adequate for the bank's risk appetite, benefiting from capital injections from NAB prior to the demerger. At end-March 2017 CYBG reported a common equity Tier 1 (CET1) ratio of 12.5%, providing an adequate management buffer over known regulatory minimum requirements, which we believe to be necessary for supporting CYBG's activities as a standalone entity. We expect that the planned switch to the IRB approach to risk-weighting measurement, which is pending regulatory approval, may result in higher regulatory capital ratios that may allow for further targeted additional loan growth. Capital is somewhat protected by the indemnity provided against conduct charges by NAB. CYBG is the holding company of the CB group and is the entity listed on the London and Sydney stock exchanges. It is intended that it will serve as the group's resolution entity should this become necessary. CYBG's ratings are equalised with those of its subsidiary CB because of CYBG's holding company role in the group, similar regulation being applicable to both companies (the UK's PRA regulates CYBG and CB on a consolidated basis), the lack of holding company double leverage and the very limited materiality of its non-bank subsidiaries. CB's dividends and interest payments are the main source of income for CYBG and CYBG's total consolidated balance sheet volume is almost entirely formed of CB's assets. We have assigned a DCR to CB as it is a counterparty to Fitch-rated transactions. The DCR is at the same level as the Long-Term IDR because under UK legislation, derivative counterparties have no preferential status over other senior obligations in a resolution scenario. SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF) The group's SR and SRF reflect Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities in the event the group becomes non-viable given its low systemic importance. In our opinion, the UK has implemented legislation and regulations that provide a framework that is likely to require senior creditors to participate in losses for resolving the group. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital issued by CYBG are notched down from its VR in accordance with Fitch's assessment of each instrument's respective non-performance risk and relative loss severity. Tier 2 debt is rated one notch below the VR for loss severity, reflecting below-average recoveries. CYBG's fixed rate reset perpetual subordinated contingent convertible notes are additional Tier 1 (AT1) instruments with fully discretionary interest payments and are subject to conversion into CYBG's ordinary shares on breach of a consolidated 7% CRD IV CET1 ratio, which is calculated on a fully-loaded basis. The securities are rated five notches below CYBG's VR. The securities are notched twice for loss severity to reflect the conversion into common shares on a breach of the 7% fully loaded CET1 ratio trigger, and three times for incremental non-performance risk relative to the VR. The notching for non-performance risk reflects the instruments' fully discretionary coupons, which Fitch considers as the most easily activated form of loss absorption. RATING SENSITIVITIES IDRS, VR, DCR AND SENIOR DEBT CYBG's and CB's VRs, IDRs, DCR and senior debt ratings are primarily sensitive to structural deterioration in profitability, through tighter margins and higher loan impairment charges, and weaker asset quality. This could be caused by a material weakening of the operating environment in the UK if the economic effect of the UK's decision to leave the EU is particularly severe on its business model CYBG's and CB's IDRs and VRs are also sensitive to a change in Fitch's assumptions around their moderate risk appetite and ability to improve profitability without raising risk materially or if the current management buffers held over minimum capital requirements are eroded materially. Upside potential is limited in the medium term given CYBG's constrained profitability and execution risks associated with the bank's restructuring programme. SUPPORT RATING AND SUPPORT RATING FLOOR An upgrade of the SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support its banks. While not impossible, this is highly unlikely, in Fitch's view. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES As the subordinated debt rating is notched down from CYBG's VR, the rating is primarily sensitive to any change in the VR. The securities' ratings are also sensitive to any change in their notching, which could arise if Fitch changes its assessment of the probability of their non-performance or loss-severity relative to the risk captured in CYBG's VR. With respect to the AT1 securities, this could arise from a change in Fitch's assessment of capital management at CYBG, reducing the holding company's flexibility to service the securities or an unexpected shift in regulatory buffer requirements, for example. HOLDING COMPANIES CYBG's VR and IDRs are sensitive to CYBG maintaining either no or a modest amount of holding company double leverage. A material increase in holding company double leverage, or a change to the role of the holding company, could result in a downgrade of CYBG's VR and IDRs. Together with the creation of separately capitalised subsidiaries, over time further expected debt issuance by CYBG could change the relative position of creditors of different group entities, which would be reflected in different entity ratings, including the holding company's VR and IDRs. The rating actions are as follows: Clydesdale Bank Long-Term IDR: affirmed at 'BBB+'; Outlook Stable Short-Term IDR: affirmed at 'F2' Viability Rating: affirmed at 'bbb+' Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Derivative Counterparty Rating: assigned at 'BBB+(dcr)' CYBG Long-Term IDR: affirmed at 'BBB+'; Outlook Stable Short-Term IDR: affirmed at 'F2' Viability Rating: affirmed at 'bbb+' Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Senior Unsecured Debt: affirmed at 'BBB+' Additional Tier 1 Debt: affirmed at 'BB-' Tier 2 Debt: affirmed at 'BBB' Contact: Primary Analyst Claudia Nelson Senior Director +44 20 3530 1191 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Krista Davies Director +44 20 3530 1579 Committee Chairperson Redmond Ramsdale Senior Director +44 20 3530 1836 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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