OREANDA-NEWS. Fitch Ratings has affirmed Clydesdale Bank Plc's (CB) and its parent's CYBG PLC's Long-Term Issuer Default Ratings (IDR) at 'BBB+'. The Outlooks are Stable. Fitch has also affirmed the Viability Ratings (VR) at 'bbb+' and Support Ratings (SR) at '5'.

A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS and VR

CYBG's and CB's IDRs and VR reflect the group's strong balance sheet, with healthy asset quality, showing very low levels of impairments, combined with healthy liquidity and sound capitalisation. However, profitability is still very low and is likely to remain under pressure from the low base rates prevailing in the UK, and by a still high cost base. Capital is somewhat protected by the indemnity provided against conduct charges by its previous owner, National Australia Bank Ltd (NAB; AA-/Stable).

CYBG has reported full-year losses since 2012, mostly the result of legacy conduct charges. Pre-impairment profitability has also been modest, as a result of an undiversified revenue stream, deleveraging of higher risk-higher return business and a high cost base. The bank has been seeking to improve profitability by growing loans, particularly buy-to-let mortgages. However, following revised projections of UK economic growth following the outcome of the EU referendum, the bank has set down a revised strategic plan, which is set to reduce its cost base significantly, largely through closing branches, increasing digitalisation and reducing its work force.

The bank still has a number of ongoing separation projects following the demerger of CB from NAB in February 2016, and restructuring costs are expected to be significant over the next 12-18 months. However, we expect that associated risks will be manageable for the bank and as it progresses with these investments, it is possible that its regulatory capital requirements will also fall.

The bank has transitioned well in terms of funding following its separation from NAB. It has been able to develop its large and stable retail deposit franchise and its loans/customer deposits ratio has improved (end-March 2016: 110%) with customer deposits forming 82% of end-March 2016 funding (excluding derivatives). The bank continues to access the wholesale markets via its secured funding platform. On-balance sheet liquidity is maintained at adequate levels, with liquid assets comprising mainly cash and high-quality sovereign exposures. This is complemented by good access to contingency liquidity sources.

Asset quality is healthy with low levels of arrears. The proportion of defaulted loans (defined as IFRS impaired loans plus loans which are over 90 days past due but not impaired) was 1.4% at end-March 2016. Impaired loans were just 0.9% of gross loans at the same date. However, the bank has some sector concentrations, including loans to the agriculture industry, which accounted for 24% of total business lending at end-March 2016.

CYBG's capitalisation is adequate for the bank's risk appetite, benefiting from capital injections from NAB prior to the demerger. At end-March 2016 CYBG reported a CET1 ratio of 13.2%. This provides a management buffer over regulatory minimum requirements, which we believe to be necessary for supporting CYBG's activities as a standalone entity.

CYBG is the holding company of the CB group and is the entity listed on the London and Sydney stock exchanges. It is also intended that it will serve as the group's resolution entity should this become necessary. CYBG's ratings are equalised with those of its subsidiary CB because of CYBG's holding company role in the group, similar regulation being applicable to both companies (the UK's PRA regulates CYBG and CB on a consolidated basis), the lack of holding company double leverage and the very limited materiality of its non-bank subsidiaries. CB's dividends and interest payments are the main source of income for CYBG and CB's assets represented 99% of CYBG's total assets at end-March 2016.

SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)

The group's SR and SRF reflect Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities in the event the group becomes non-viable given its low systemic importance. In our opinion, the UK has implemented legislation and regulations that provide a framework that is likely to require senior creditors to participate in losses for resolving the group.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

Subordinated debt and other hybrid capital issued by CYBG are notched down from its VR in accordance with Fitch's assessment of each instrument's respective non-performance risk and relative loss severity. Tier 2 debt is rated one notch below the VR for loss severity, reflecting below-average recoveries.

CYBG's fixed rate reset perpetual subordinated contingent convertible notes are additional Tier 1 (AT1) instruments with fully discretionary interest payments and are subject to conversion into CYBG's ordinary shares on breach of a consolidated 7% CRD IV CET1 ratio, which is calculated on a fully-loaded basis. The securities are rated five notches below CYBG's VR. The securities are notched twice for loss severity to reflect the conversion into common shares on a breach of the 7% fully loaded CET1 ratio trigger, and three times for incremental non-performance risk relative to the VR. The notching for non-performance risk reflects the instruments' fully discretionary coupons, which Fitch considers as the most easily activated form of loss absorption.

RATING SENSITIVITIES

IDRS and VR

CYBG's and CB's VRs and IDRs are primarily sensitive to structural deterioration in profitability, through tighter margins and higher loan impairment charges, and weaker asset quality. This could be caused by a material weakening of the operating environment in the UK if the economic effect of the UK's decision to leave the EU is particularly severe.

CYBG's and CB's IDRs and VRs are also sensitive to a change in Fitch's assumptions around their moderate risk appetite and ability to improve profitability without raising risk materially. Upside potential is limited in the medium term given CYBG's constrained profitability and execution risks associated with the bank's restructuring programme.

SUPPORT RATING AND SUPPORT RATING FLOOR

An upgrade of the SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support its banks. While not impossible, this is highly unlikely, in Fitch's view.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

As the subordinated debt rating is notched down from CYBG's VR, the rating is primarily sensitive to any change in the VR. The securities' ratings are also sensitive to any change in their notching, which could arise if Fitch changes its assessment of the probability of their non-performance or loss-severity relative to the risk captured in CYBG's VR.

With respect to the AT1 securities, this could arise from a change in Fitch's assessment of capital management at CYBG, reducing the holding company's flexibility to service the securities or an unexpected shift in regulatory buffer requirements, for example.

HOLDING COMPANIES

CYBG's VR and IDRs are sensitive to CYBG maintaining either no or a modest amount of holding company double leverage. A material increase in holding company double leverage, or a change to the role of the holding company, could result in a downgrade of CYBG's VR and IDRs.

Together with the creation of separately capitalised subsidiaries, over time further expected debt issuance by CYBG could change the relative position of creditors of different group entities, which would be reflected in different entity ratings, including the holding company's VR and IDRs.

The rating actions are as follows:

Clydesdale Bank

Long-Term IDR: affirmed at 'BBB+'; Outlook Stable

Short-Term IDR: affirmed at 'F2'

Viability Rating: affirmed at 'bbb+'

Support Rating: affirmed at '5'

Support Rating Floor: affirmed at 'No Floor'

CYBG

Long-Term IDR: affirmed at 'BBB+'; Outlook Stable

Short-Term IDR: affirmed at 'F2'

Viability Rating: affirmed at 'bbb+'

Support Rating: affirmed at '5'

Support Rating Floor: affirmed at 'No Floor'

Additional Tier 1 debt: affirmed at 'BB-'

Tier 2 Debt: affirmed at 'BBB'