'Coalition of chaos' leaves Clydesdale unscathed

  • By Elizabeth Fry

The Clydesdale and Yorkshire Bank turnaround story is gaining traction in the face of a more subdued lending environment, despite the current political turmoil in Britain.

As long as Prime Minister Theresa May has the confidence of the majority of MPs in the House of Commons when Parliament next meets, the Conservatives will be able to form a government. 

However, this comes at a time when both the UK economy and business confidence are weakening and Brexit negotiations are about to begin. 

A vote of no confidence in May could see Labour’s Jeremy Corbyn - who recently branded the impending Tory-DUP alliance a 'coalition of chaos' - become Prime Minister of a minority government. 

“Under this scenario, things would get a lot harder for banks and business in general as the corporation tax rate would increase from 20 per cent to 26 per cent and there would be a new 50 per cent tax for those earnings over £123,000,” said Bell Potter analyst TS Lim.
 

The Clydesdale challenge

The uncertainty is exacerbated by weakening business confidence and a slowing economy, he said, adding that 0.2 per cent growth in the 2017 first quarter was the worst performance among G7 countries and in the European Union. Plus, economic growth is forecast to grow at just 1.7 per cent in 2017 and 1.3 per cent in 2018.

Yet in the midst of the ‘coalition of chaos’, the Clydesdale cost-out story is intact according to Lim, who is predicting a Tory government as the likely outcome in Westminster.

As he sees it, chief executive David Duffy’s success in turning around Allied Irish Banks should provide a clear indication of what could go right for the challenger bank over the next three years in terms of cutting costs.

To recap, Clydesdale and Yorkshire Banking Group - spun out of parent National Australia Bank - has driven underlying costs down by 7 per cent to £348 million in the 2017 first-half and has flagged a similar outcome in the second half.

“Over the medium term, we believe Clydesdale cost-outs will be easier to achieve than revenue growth in a period of weakening economic growth and business confidence and also leading up to actual Brexit - either hard or soft.”
 

Value driver

Starting with a first-half 70 per cent cost-to-income ratio, Duffy’s target is for 55-58 per cent by 2019, achieving more than £100 million of underlying cost savings. 

“This should remain the most important value driver available to the bank under current circumstances as well as to its chief executive given his £1.5 million performance rights that will vest over the next three years,” added Lim

“To put this into perspective, Allied Irish’s target cost-to-income ratio under Duffy was 50 per cent and 49 per cent was achieved by 2015 largely via streamlining the retail network and closing 42 per cent of the branches between 2011 and 2015. The approach is very similar to his current strategy for Clydesdale."

Lim estimates that Duffy will reach his target and will save £100 million in underlying costs between 2015 and 2019.

"The denominator in the cost-to-income ratio would be a different matter in a weakening economy given slowing top line growth and we expect 55-58 per cent cost-to-income ratio to be achieved only in 2020," he said.

Lim has factored in more aggressive cost management into profit forecasts in response to a more subdued lending environment. Bad debt forecasts for British banks have improved slightly as both unemployment and interest rates in the UK are expected to remain at current levels.

The end result for Lim is a 5 per cent cut to underlying net earnings for this year to £155 million. The analyst's profit forecasts show a rise to £183 million in 2018, and then to £243 million two years later.