Virgin Money sale is UK challenger banks’ swansong

Virgin Money UK

08/03/2024 07:45

(The author is a Reuters Breakingviews columnist.  The opinions
expressed are her own.)
    By Aimee Donnellan
       LONDON, March 7 (Reuters Breakingviews) - It’s the end
of an era. If Nationwide Building Society  NBS.L  succeeds in
swallowing up Virgin Money  VMUK.L  for 2.9 billion pounds and a
tasty premium, it will shatter regulators’ dreams of having
bite-sized lenders competing with larger players. As costs and
risks rise, banks are finding out that big is beautiful once
again.
    So-called challenger banks rose from the ashes of the 2008
financial crisis. After unwieldy lenders like Lloyds TSB and
Royal Bank of Scotland got into trouble, regulators encouraged a
new breed of smaller banks to provide diversification and
competition. Many of these minnows have already disappeared.
Last month, Barclays  BARC.L  bought Tesco Bank for 600 million
pounds. In December, Coventry Building Society made a 700
million pound offer for the Co-op Bank. Now Nationwide looks set
to buy Virgin Money, one of the largest small banks left
standing.
    As it happens, Virgin Money is itself a rollup of minnows –
it bought Northern Rock amid the 2008 financial crisis, then was
absorbed into CYBG, a combination of Clydesdale Bank and
Yorkshire Bank that maintained the Virgin brand. Even so it’s
still a relatively small player, on which higher interest rates
have piled pressure. Last November it reported a 24% slump in
its 2023 pre-tax profit to 593 million pounds, below the 625
million pounds analysts had expected. In Virgin Money’s case,
the bank offered higher loan-to-value mortgages and extended
larger amounts of credit to customers so when interest rates
ballooned to over 5%, more fell behind in paying interest on
their loans.
    Despite these issues, Nationwide is not getting Virgin on
the cheap. Nationwide’s CEO Debbie Crosbie’s offer is pitched at
a 38% premium to Virgin’s share price on Wednesday and is
equivalent to 60% of Virgin’s tangible book value, similar to
the valuation fetched by Tesco Bank. Yet last year the group
only made a 4% return on tangible equity, and the deal isn’t
likely to generate big synergies.
    Still, the deal’s rationale makes sense. The combination
will create the second-largest mortgage lender in the UK and
allow the building society to better compete with rival Lloyds
Banking Group  LLOY.L . Virgin’s 9 billion pounds in business
lending will also enable Nationwide to break into the market of
lending to small firms. And although neither side has revealed
the exact accounting gains, a person close to the situation said
the negative goodwill benefit from buying the assets at a
discount would exceed the hit from having to recognise some
losses on Virgin’s balance sheet.
    Bad lending and a lower customer quality meant the
challenger banks didn’t challenge their bigger rivals. Last
year, NatWest  NWG.L  delivered a near 18% return on tangible
equity. By adding Virgin, Nationwide will both cement its place
among the UK’s big banks and end the country’s experiment with
lending minnows. As long as regulators and CEOs ensure that
large players don’t repeat the mistakes of 2008, that may not be
a bad thing.
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    CONTEXT NEWS
    Nationwide Building Society on March 7 said it had reached a
preliminary agreement to buy Virgin Money UK for 2.9 billion
pounds. The all-cash deal would create Britain’s second-largest
savings and mortgage provider.
    Nationwide said it would pay 220 pence for each Virgin Money
share – a premium of 38% on the lender’s share price on March 6.
Shares in Virgin Money were 36% higher at 216.5 pence at 1039
GMT on March 7.
    If the deal proceeds as announced, the new entity would have
combined assets of approximately 366.3 billion pounds, with
lending and advances of around 283.5 billion pounds. Nationwide
said it did not intend to make any “material changes” to the
size of Virgin Money’s 7,300-strong workforce in the near term.

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Graphic: UK mortgage lending is dominated by big banks    https://reut.rs/3wCp7BW
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 (Editing by Francesco Guerrera, Streisand Neto and Oliver
Taslic)
 ((For previous columns by the author, Reuters customers can
click on  DONNELLAN/ 
Aimee.Donnellan@thomsonreuters.com; Reuters Messaging:
Aimee.Donnellan.thomsonreuters.com@reuters.net))