Finance

Duncan Mavin is a former Bloomberg Gadfly columnist.

CYBG is a British challenger bank that claims 175 years of history. It's also burdened by an instantly forgettable name.

Awkward branding aside, the U.K. unit of National Australia Bank -- known to its customers as Clydesdale Bank and Yorkshire Bank -- has outlined a decent case to investors as it prepares for an initial public offering in February.

U.K. Gross Mortgage lending
Source: CYBG

First, the balance sheet looks sturdy, with a Tier 1 capital ratio of 13.2 percent, more than the 12.5 percent average for U.K. banks. At 7.1 percent, the leverage ratio is second only to Shawbroook, another small lender, according to Bloomberg data. Both metrics put CYBG firmly at the safer end of the U.K. banking industry.

Costs for past misconduct -- mostly the mis-selling of payment-protection insurance -- are covered off by 2.1 billion pounds ($3.2 billion) of provisions and an indemnity from the Australian bank.

But the balance sheet is yesterday's banking metric. How does this challenger aim to deliver profit growth?

The bank says that, based on its recent performance, it can expect to increase consumer lending by as much as 50 percent over the next five years and loans to small-and-medium-sized businesses by as much as 25 percent.

There's plenty of room to grow faster than that. CYBG has just 4 percent of the SME lending market and accounts for 2 percent of gross U.K. loans.

Even so, the bank will have to steal market share from rivals. The "big four" British banks still control about 80 percent of the country's checking account market. And there's no shortage of other so-called challenger banks (read smaller upstarts) trying to break up what they view as a cosy oligopoly.

CYBG's executives are also counting on an uptick in the U.K. economy and higher interest rates -- a forecast rise of 100 basis points over the next five years doesn't seem at all stretching.

The bank's cost-to-income ratio is way above the industry norm at 75 percent, and executives claim they can get it down below 60 percent. That sounds like a big reach, but even that target would still leave the bank behind most of its peers. Lloyds is targeting a ratio of just 45 percent by the end of 2017, compared with 48 percent now. At Clydesdale, there should be plenty of room for more efficiency and moving processes online.

Overall, the bank's return on tangible equity is about 5.1 percent now and it's targeting a double-digit return in the medium term, slightly more than the average for its U.K. peers.

The mooted valuation of about 2.5 billion pounds for the demerged NAB unit would value CYBG at a discount to book value. That's hardly surprising given the Australian bank is desperate to be rid of it so it can focus on its more profitable domestic operations.

At that price and in those circumstances, investors might like this challenge -- whatever the company calls itself.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Duncan Mavin in London at dmavin@bloomberg.net

To contact the editor responsible for this story:
Edward Evans at eevans3@bloomberg.net