Morgan Stanley, the sole sponsor for National Australia Bank's demerger and dual-listing of its UK subsidiary, Clydesdale and Yorkshire Bank, had to navigate a complex deal structure and a sharp sell-off in banking stocks.

When Clydesdale and Yorkshire Bank was demerged from National Australia Bank (NAB) alongside a London initial public offering (IPO), the transaction called for split-second timing with no going back. The markets chose that moment to savage the banking sector. Yet investors believed the equity story and the shares traded up. Morgan Stanley was sole sponsor.

As part of a UK growth strategy, NAB bought Clydesdale Bank in 1987, followed by Yorkshire Bank three years later, and established a common platform for the two brands. After it became clear that northern hemisphere economies and banking were more affected than Australia by the financial crisis, NAB began to consider how to get out.

When it raised the subject with Morgan Stanley towards the end of 2008, it was clear that the UK business was not going to be easy to exit. "For the next four years we looked at strategic exits, but it was quite difficult," says William Chalmers, co-head of Morgan Stanley's global financial institutions group. "The business's performance was relatively modest, potential buyers were very hesitant and the impact of regulation was rising across the sector."

Formulating a plan

The UK bank needed to raise capital and faced claims for mis-selling payment protection insurance and interest rate swaps. So NAB and its advisers took matters into their own hands and began to explore the possibility of a demerger.

"A demerger meant we would not be dependent on market conditions for finding a buyer," says Ian Hart, managing director, UK investment banking at Morgan Stanley. "This was a deal that could be done without relying on a third party."

A demerger would not require anyone to put their hands into their pockets. NAB shareholders would simply receive Sydney-listed shares in what is now Clydesdale and Yorkshire Bank Group (CYBG). It skirted the problem of how to establish the true long-term value of the business by simply giving it to shareholders, who could eventually benefit from any upside or take the money and run.

But then the structure began to evolve. Instead of handing the entire business to shareholders, perhaps a share split could be combined with an IPO. That way, the parent would raise some money for itself and CYBG would end up as a proper UK-listed entity. Something similar to this had been done before, in 2003, when Australian insurer AMP demerged its UK interests in the shape of fund manager Henderson. The demerged company was, and remains, listed in both Sydney and London.

It was decided to pursue the demerger plus IPO option, with 75% of the shares going to existing shareholders and 25% sold via a London IPO. "The IPO created a UK listing which, for a UK-headquartered plc, was important, because the shares have a natural following in their home market," says Martin Thorneycroft, Morgan Stanley's head of equity syndicate for Europe Middle East and Africa. An IPO would also enable more forensic price discovery, as investor education by research analysts and management shed a light on who might buy the shares and at what price.

In 2014, the process shifted up a gear with the arrival of a new NAB CEO, Andrew Thorburn, previously CEO of NAB subsidiary Bank of New Zealand. He understood the merits of the plan and, cutting through the debate over timing and value, determined to get on with it.

One bank, two domiciles

In order to prepare for the demerger and IPO, a number of issues had to be addressed. One was the tradability and fungibility of the shares. Given that 75% of the shares would be going to a heavily Australian shareholder base, who were not natural holders of UK bank stocks, flowback was a concern. The shares would be listed on the Australian Stock Exchange (ASX) via Chess Depositary Interests (CDIs), which allow international companies to trade on the local market.

"It was important to make sure that the CDIs were eligible for inclusion in the ASX index, and that London considered them as part of the free float," says Mr Thorneycroft. "If you own a CYBG CDI, you can sell it in London – there is no arbitrage." He accepts that over time, trading will probably migrate to London but points out that the process is taking a long time for Henderson, a majority of whose shares are still held in Australia.

It was also crucial that the demerger and IPO were effected at the same time. One could not happen without the other, which reduced room for manoeuvre in case of emergency.

The conduct issues were the subject of much analysis over how far they had been dealt with and how big future claims might be. The UK regulator told NAB to set aside £1.7bn ($2.43bn) to cover any future claims – NAB completed a A$5.5bn ($3.93bn) rights issue in June 2015 to raise the necessary funds.

Turnaround story

Finally, CYBG needed an equity story that was strong enough for investors to buy into. Its theme was, in essence, restructuring and recovery. Investors were told that this was a full-service challenger bank, not a monoline specialist, and one that was active in both business and retail markets. It was led by a new and experienced management team, under new CEO David Duffy, who was fresh from turning around Allied Irish Banks. "David's ability to sell his track record in restructuring was critical," says Mr Thorneycroft.

Another positive was that the bank was well capitalised, with a common equity Tier 1 ratio of 13.2%. With the £1.7bn claims provision and a clear-out of its toxic commercial property loan portfolio, it was clean. It had a strong brand and about 10% market share in each of its home markets of Scotland and Yorkshire. "And it has a very strongly deposit-funded balance sheet," adds Mr Hart.

Challenges in the equity story were the risk of flowback (which never materialised), the paucity of banking margins generally, a subdued macroeconomic environment and, more specifically, tighter regulation in the UK buy-to-let mortgage market, which is one of CYBG's niche specialities.

Morgan Stanley as sole sponsor was joined by Bank of America Merrill Lynch and Macquarie Capital as joint global co-ordinators and bookrunners. Market conditions in early December 2015 were relatively benign and the scheme of arrangement for the demerger was duly filed. From now on, the process was irreversible. "You couldn't pull the demerger and come back later," says Mr Hart. But by the time an intention to float was published, one week on, the market had taken a distinct turn for the worse.

Down to the wire

NAB and CYBG management were undeterred. Investor education began, first in Australia and then, in the new year, in the UK and US. As January unfolded, equities, and bank shares in particular, took a beating. "CYBG's major peers were down by double digit percentages between the beginning of January and when we set the price range," says Mr Thorneycroft.

On 18 January, the price range was set at 175p to 235p, and bank share prices continued to fall. Yet the issue was fully subscribed after three days and went on to be over-subscribed "multiple" times. Shares were due to begin trading on February 2, 2016. The price was fixed at 180p the night before, representing the lowest price to tangible book value ratio in its peer group but the highest earnings multiple.

That same night, it emerged that Moody's was about to downgrade CYBG's long-term deposit rating. It was decided to delay trading by one day to allow shareholders time to absorb this new information. In a statement, the bank said it did not believe the downgrade would have any material impact. 

"Some investors revised orders, but others increased theirs after conversations with management," says Mr Chalmers. "They felt this was an exercise in transparency." It was a nail-biting day. The FTSE 100 index fell 2.3% and the FTSE 350 banks index fell 3.9%. But when dealing began the following morning, CYBG shares traded up. They remained above their issue price over the next couple of weeks, even as most other UK banks continued to fall.

Mr Thorneycroft likens the simultaneous demerger and IPO to landing two planes at exactly the same time on a moving ship in a choppy sea. Mr Chalmers concludes: "It shows there is a market appetite for well-managed, clean challenger bank shares."


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