Virgin MoneyJun 27 2018

Challenger banks join forces

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Challenger banks join forces

Since the financial crisis the challenger banks have flourished, moving into areas once occupied by the traditional banks, as the latter worked to rebuild their balance sheets post-2008.

Now the main banks are moving into a growth phase, making life more difficult for the challengers as they are being forced to adapt. Such is the case with Virgin Money, whose share price has been under pressure over the past year, as shareholders have struggled to see how the bank could meet the new aggression in the mortgage market.

Takeover

So last week, the board agreed a takeover from CYBG, otherwise known as Clydesdale and Yorkshire Bank, in a deal that creates the sixth largest bank in the UK. The CYBG is the larger bank and so its chief executive, chairman and chief financial officer will move into the enlarged group in their respective roles while Virgin Money chief executive, Jayne-Anne Gadhia will be stepping aside, but acting as a consultant while the merger takes place.

Key points

  • Virgin Money has been taken over by CYBG
  • Virgin Group is to receive £15m a year from licensing its brand
  • The merger may reduce the availability of mortgage products

The deal – which is subject to shareholder and regulatory approval – represents astonishing good value for Richard Branson; in exchange for his stake, the Virgin Group entrepreneur will licence the Virgin brand for £15m a year, as the enlarged group will use the Virgin name across the business. 

Clearly there is a risk attached if something bad happens to the brand name under new management.

A spokeswoman for CYBG said: “Virgin customers will be migrated onto the technology platform that we have developed and on which we have spent £250m. From a migration point of view that’s over 100,000 customers that will be transferred over. It will very much be a phased approach, and we switched over 20,000 customers to our digital banking service from other providers without incident.”

The move is seen as a complementary match, with CYBG having a big presence in the small business sector, and Virgin Money in retail, and with the latter having a strong presence among the broker community – 90 per cent of its mortgages are sold through intermediaries – it is expected to create 1,500 job losses. 

Shailesh Raikundlia, banking analyst at Panmure Gordon, said: “I think in terms of the potential combination, it’s been talked about for a while because they have had quite complementary product sets. Virgin Money has been very strong in the mortgage market and credit card market, and it has been increasing market share quite significantly.

“CYBG has more of a franchise in the SME market, and in deposits and current accounts. In terms of the fit it was very complementary and a good strategic rationale.”

In addition Virgin Money is quite weak in current accounts, as it has a small branch network, and it was looking to expand in that part of the market. It was also talking about setting up a digital bank, which has a lot of capital investment, but is something that CYBG has already done. Other areas of complementarity exist over branding – Virgin has a much stronger brand than Clydesdale and Yorkshire, and it is for this reason that the enlarged group is paying initially £12m a year in the first year, moving up to £15m in the fourth year, and after that 1 per cent of turnover.

Ray Boulger, senior mortgage technical manager at John Charcol, said: “They will pay £15m in a way for not doing anything but it does mean their brand is exposed,as if the new group is doing something like the TSB [replatforming] it could damage their brand. It’s a price clearly worth paying - that’s the risk worth taking.” 

Perhaps some of the potential downside is what the future holds for the range of products offered by the combined group.

Mr Boulger said: “It will reduce consumer choice. The larger bank will be stronger, it will reduce competition. I think mergers like this are always a concern. Eventually the mortgage product range will converge and instead of having two different product ranges we will end up with one product range.”

Mr Boulger’s view is not universal. David Hollingworth, associate director, communications at L&C Mortgages, said: “There could be relatively little change in terms of the product offering. I think the appeal is to grow scale for CYBG. 

“I wouldn’t be surprised if the Virgin offering continues as it is, and I wonder whether we will see both brands continuing.

“Virgin has worked hard in the broker market. If you go back far enough, it grew out of the remains of Northern Rock and has been very broker focused; service has been pretty good and some of the products have been sharply priced. 

“Clydesdale has more long-term buy-to-let and residential [offerings] and has offered products to certain professions – it has that high net worth sector and has that slightly more bespoke approach it can use. Both of these can remain relevant to the broker space.”

The question is whether they build on that with one brand or two. So how did these two banks end up doing a deal?Mr Raikundlia said: “Virgin Money has recently come under a lot of pressure because the big banks have started coming back with more competitive rates. They can afford to be more competitive because they have a big current account [division]. 

“The top five banks have an 80 per cent market share, and they were not as aggressive because they were repairing their balance sheet, post the financial crisis.”

Growth phase

“They’re now moving back into growth phase and starting to grow their business after retrenchment, so there’s now a lot of competition in the mainstream mortgage market so that analysts, such as myself, were starting to talk about having these issues,” he added.

Margins were starting to come under pressure, andthere were issues in credit card accounting, where Virgin is very big in 0 per cent balance transfers, which the regulator is starting to clamp down on.

From an accounting perspective there were lower rates of return on credit cards, and combined with the other pressures, the share price was depressed. TSB was considered to be another potential courtier, until it ran into IT problems.

What does it mean for Ms Gadhia, who built the business up from scratch? Mr Raikundlia said Mrs Gadhia was well regarded in some quarters, until the share price came under pressure. 

The Virgin business has only been on the stock market for four years, having been launched with investment from Mr Branson and Wilbur Ross, the private equity investor who is currently the US commerce secretary.

After launching in its current incarnation in 2010, the business has been sold for £1.7bn. Perhaps not the best financial outcome for a business that came to market at £1.25bn, but strategically a good result for the long term.

Melanie Tringham is deputy features editor at Financial Adviser and FTAdviser.com