National Australia Bank Ltd. (ASX: NAB) is left with a tricky task of talking up its troublesome UK operations after management said it was making the divestment of the business a priority for this year.
Shareholders don't seem too taken with the news. Even though shares in NAB jumped 1.94% to $34.12 this morning, the jump is largely in line with the gains made by its peers like Australia and New Zealand Banking Group (ASX: ANZ).
NAB's management wants to spin-off its Clydesdale Bank division into a separately listed entity where up to 80% of the new float on the London Stock Exchange will be owned by existing shareholders while the balance will go to institutional investors.
To keep local investors happy, Clydesdale will also have a secondary listing on the ASX. Here are 10 things investors should know about the UK banking business:
- The business has meaningful scale as it is the biggest mid-tier bank in the UK with 294 branches, £28 billion ($58.4 billion) in gross loans and 2% share of the mortgage market.
- NAB believes Clydesdale has room to steal market share from the five big banks in the UK, which includes the likes of Lloyds and RBS. The top five banks control about 93% of the small-to-medium-size business lending market and 57% of the mortgage market.
- Clydesdale mortgage compound annual growth rate (CAGR) is at 10% since 2012, and while it has run down its business loans in the aftermath of the global financial crisis, new small business customer growth is up 70% since December 2014.
- While Clydesdale was a thorn in NAB's side due to its poor quality loan book, the bank has managed to clear the decks and will leave Clydesdale with a strong balance sheet that will boast a tier 1 common capital ratio of 11.9% and a non-performing loan ratio of 1.6%. Those are pretty good ratios.
- Pre-tax profit over the past three years has risen strongly to £222 million in 2013-14 (year end is September) from £38 million. This is driven more by cost cutting with costs dropping 7 percentage points to 70% of income over the period and a big drop in impairment charge.
- Underlying pre-tax profit for the first half of the current financial year is up 7.8% to £111 million but the big tailwind from falling impairment losses is probably waning.
- Clydesdale market cap could reach around £2.8 billion if the stock trades on similar multiples to regional Australian bank stocks.
- Net interest margin (NIM), which is the profit margin between how much it costs the bank to borrow funds and the interest it can charge customers, has been reasonably stable at around 2.2%. This compares well to the margins of Australian banks. For instance, the Commonwealth Bank of Australia (ASX: CBA) reported a NIM of 2.1%. NIM is under pressure here in Australia and in the UK, but Clydesdale believes this will be offset by growth in its loan book.
- The UK trading environment is reasonably supportive of further growth in the sector with unemployment falling to its lowest levels since the global financial crisis and high consumer confidence. Gross domestic product (GDP) growth is forecast at around 2.1%, which will make it the envy of Europe.
- Shareholder returns is a weak point. While NAB claims return on tangible equity (RoTE) is 8.1%, return on equity (ROE) – which is a measure more commonly used to compare bank stocks here – is probably hovering around 5.5%. NAB's ROE was 11.8% for 2013-14.
It's too early to say how the spin-off will go as it's too early to tell. A lot will depend on whether new institutional investors will get excited about the pricing of the Clydesdale stock.
However, history has shown that spin-offs do outperform the market and their parent stock over a 12-to-24-month period.
This outperformance has yet to show up for South32 Ltd (ASX: S32) since it was divested by BHP Billiton Limited (ASX: BHP), but it's early days yet.
