Shareholders in UK-based Clydesdale Bank (ASX: CYBG) have been dealt another blow today. Prior to today’s announcement, CYBG shareholders had already suffered a 60% loss during the year. Clydesdale surprised the market by forecasting that its legacy PPI costs would require provisions of between £300M ($540M) and £450M ($810M) to cover compensation and remediation associated with the PPI product. PPI is an insurance product often combined with loans sold to consumers. Customers almost always never needed it and struggled to make insurance claims against it. The bank expects to be able to provide a more accurate estimate of the PPI-related costs when it presents full year results on 28 November 2019. This final remark leaves investors with uncertainty regarding the true impact of the compensation and remediation.

Clydesdale’s Q3 Trading Update had pointed out that information requests regarding the PPI product had increased but that it was too early to determine if they would materialise. During August, around 9,000 daily requests were received by Clydesdale expressing concerns over PPI compensation. This was a greater number of requests than the prior 8 months combined. Furthermore, Clydesdale bore the brunt of elevated complaints throughout August, with around 5,000 per week during the first four weeks of the month and an inflated 22,000 complaints in the final 3 days of the month.

Clydesdale revealed that if the provision had been incurred as at June 30 2019, the Group’s CET1 ratio would have fallen between 130 and 190 basis points to between 12.7% and 13.3%, retaining a buffer of at least 1.7% above the fully-loaded CRD IV minimum CET1 capital requirement of 11.0%.

If regulation increases Clydesdale’s capital requirements, the bank could be required to raise capital at a heavily discounted valuation. Investors may be attracted to Clydesdale to diversify their income across multiple currencies to benefit from a falling Australian Dollar, with Clydesdale generating earnings in British Pound Sterling. However, there are valid concerns that Clydesdale could make further provisions, negatively impacting its CET1 ratio.

Bears worry that banks with low buffers above their capital requirements would perform most poorly in a recessionary environment where default rates and bad debt write-offs generally rise. Investors may want to look domestically towards Australian banks – all of which offer a yield far higher than the 1% RBA cash rate.

 

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September 6, 2019