CYBG PLC 'BBB-/A-3' Ratings Affirmed As Virgin Money Integration Progresses; Outlook Stable

  • Bank nonoperating holding company CYBG PLC has announced its first quarter of trading performance following its transformational acquisition of Virgin Money, which it completed in mid-October 2018.
  • By our measures, CYBG's capitalization is a little lower than we had assumed at the time of the acquisition offer in June 2018, but our overall opinion of CYBG's credit profile and performance prospects remains unchanged.
  • We are therefore affirming the 'BBB-/A-3' long- and short-term issuer credit ratings on CYBG.
  • We are also affirming our 'BBB+/A-2' long- and short-term issuer credit ratings on Clydesdale Bank PLC, the main operating bank of CYBG.
  • The stable outlook reflects our expectation that CYBG's management will move quickly and effectively to integrate Virgin Money and work toward its planned cost synergies. The outlook also assumes that asset quality will remain resilient.
LONDON (S&P Global Ratings) Feb. 11, 2019--S&P Global Ratings said today that 
it affirmed its 'BBB-/A-3' long- and short-term issuer credit ratings on 
U.K.-incorporated bank nonoperating holding company CYBG PLC. The outlook is 
stable.

At the same time, we affirmed our 'BBB+/A-2' issuer credit ratings and 
'A-/--/A-2' resolution counterparty ratings on the main operating bank 
Clydesdale Bank PLC. The outlook on Clydesdale Bank is stable. 

Finally, we affirmed the issue ratings on the hybrid instruments issued by 
CYBG.

The affirmation follows CYBG's announcement of its first trading update after 
the completion of its transformational acquisition of Virgin Money in 
mid-October 2018. In addition, we have updated our view of CYBG's 
capitalization and its trajectory, by our measures. Taken together, we believe 
that CYBG's credit profile and performance prospects remain unchanged since 
our ratings affirmation at the time of the transaction announcement in June 
2018. The ratings on CYBG remain supported by its solid capitalization, sound 
asset quality, and comfortable funding and liquidity profiles, and the 
potential to improve statutory earnings as a result of the enhanced U.K. 
retail banking franchise that the Virgin Money transaction provides.

With reported pro forma combined assets of over £88 billion on Sept. 30, 2018 
(CYBG's year-end), CYBG ranks as the seventh-largest U.K.-focused bank, having 
broken clear from a number of other U.K. lenders in terms of size. CYBG also 
now ranks among Europe's 50 largest banks, by our capital measures. Broadly, 
the Virgin Money acquisition has led to a doubling in size of CYBG's balance 
sheet.

CYBG's trading statement for the three months to Dec. 31, 2018 indicates early 
progress in the integration of Virgin Money, which will continue to September 
2021 (FY2021). Notably, CYBG slightly upped its net interest margin guidance 
for FY2019 to 1.65%-1.70%, in spite of the ongoing margin pressures in U.K. 
mortgage lending. CYBG also increased its annual net run-rate cost synergies 
to a minimum of £150 million by the end of FY2021 from £120 million 
previously. CYBG states that planned restructuring costs over this period will 
still total around £240 million. This, combined with other reported 
transaction-related exceptional charges of £144 million in the first quarter 
of FY2019, means we expect FY2019 to be another year of weak statutory 
earnings from CYBG.

By our measures, our combined view of CYBG's capital and risk remains a 
credit-neutral factor, but we have adjusted how we arrive at that conclusion. 
Our updated view of capitalization contrasts with CYBG's statement that its 
regulatory common equity Tier 1 ratio was 14.5% on Dec. 31, 2018, a level that 
is broadly similar to that of U.K. peers, as our risk weightings are more 
conservative. 

CYBG's risk-adjusted capital (RAC) ratio was 10.4% on Sept. 30, 2018, down 
from 12.2% the year before, mainly due to large payment protection insurance 
(PPI) provision charges of over £300 million in FY2018. On a pro forma 
combined basis, we estimate that this metric is a little below 10%. On a 
prospective basis, we expect RAC to remain close to the 10% mark as we assume 
low- to mid-single-digit annual credit growth through FY2021 and a rebound in 
statutory earnings after FY2019. Our projected RAC range is now 9.5%-10.0%, 
down from over 10.0% previously. We have offset this revised view of capital 
and earnings by improving our risk position assessment. This is because the 
asset quality metrics for the combined loan book compare well to those of U.K. 
peers; the Virgin Money transaction has reduced the weighting of buy-to-let 
mortgages in the mortgage book; and the potential downside risk to 
capitalization from unknown final PPI charges or unexpected integration 
charges is now much lower.  

While cost savings are a key driver of the acquisition rationale, we do see 
additional scope for CYBG to grow its business and improve the strength and 
quality of its earnings profile. One element of this is small-to-midsize 
enterprise (SME) banking. A potential catalyst could be the outcome of the RBS 
Capability and Innovation Fund, with the first pool of recipients set to be 
announced in late February 2019. CYBG's loan balances of £71.9 billion on Dec. 
31, 2018 are dominated by U.K. residential mortgages (83%), with the balance 
comprising SME lending (11%) and retail unsecured lending (6%).  

We continue to factor one notch of support into the ratings on Clydesdale Bank 
to reflect the enlarged group's additional loss-absorbing capacity (ALAC) 
buffers. On Sept. 30, 2018, CYBG's ALAC ratio was 5.7%, up from 5.5% the year 
before, which is above our 5% threshold for one notch of uplift. On a pro 
forma combined basis, we estimate that this metric is a little bit higher; 
this estimate takes into account the £250 million Tier 2 instrument that CYBG 
issued in December 2018, and the increased contribution of excess total 
adjusted capital in light of the aforementioned revision of our capital and 
earnings assessment. We believe this ratio is likely to remain supported, and 
possibly grow over time, as regulatory requirements oblige CYBG to increase 
the buffer of instruments that we expect will be ALAC-eligible.

Finally, in terms of a peer comparison, in addition to the six largest U.K. 
banking groups, we also compare CYBG to international banks that rank outside 
the largest banks and have similar stand-alone credit profiles (SACPs) or 
unsupported group credit profiles (UGCPs). These peers include Bendigo and 
Adelaide Bank Ltd. in Australia (SACP of 'bbb+'), Argenta Spaarbank N.V. in 
Belgium ('bbb+'), and UBI Banca SpA in Italy ('bbb-'). Other peers with the 
same UGCP as CYBG include AIB Group PLC and Bank of Ireland Group PLC. 

CYBG PLC
The stable outlook reflects our expectation that CYBG's management will move 
quickly and effectively to integrate Virgin Money and work toward its planned 
cost synergies in the next 18-24 months. The outlook also assumes that our 
view of prospective U.K. bank asset quality does not materially weaken in the 
context of the U.K.'s forthcoming departure from the EU.

We do not anticipate any ratings upside in the next 12 months as management 
works through the early stages of the integration at a time when CYBG's net 
interest margin is facing downward pressure and the U.K. economic outlook is 
more uncertain than normal. Over time, we could raise the ratings if we 
observe more robust and sustainable growth than we anticipate in CYBG's 
national franchise, especially with SMEs, leading to more diverse revenue 
streams and predictable statutory earnings.

As we view the Virgin Money acquisition as a transformational transaction, 
poor execution of the planned integration has the potential to lower the 
ratings. We could also lower the ratings if CYBG's risk appetite proves to be 
more aggressive than we assume.

CLYDESDALE BANK PLC
The stable outlook reflects that on CYBG.

An upgrade of Clydesdale Bank would principally depend on an uplift of the 
UGCP, as described above. In addition, if CYBG makes quicker progress than we 
expect in terms of its minimum requirement for own funds and eligible 
liabilities issuance, we could raise the ratings if its ALAC buffer 
sustainably exceeds our 8% threshold for two notches of ALAC support within 
the long-term rating.

We could consider lowering the ratings if we revised the UGCP downward, or if 
the ALAC buffer is below our 5% threshold for one notch of ALAC support and we 
did not see a clear growth path.  
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