News of a cash acquisition of Virgin Money by Nationwide has brought some short-term relief for the former’s long-suffering shareholders.
The £3 billion potential deal would be at a 38% premium to Virgin Money’s share price prior to the merger announcement on March 7. Analysts at Jefferies further note that it is also at a slightly higher valuation than the deal agreed for Tesco Bank by Barclays a month earlier (0.65x book value versus 0.6x book, respectively).
To that extent, David Duffy can exit his eight-year tenure as the target company’s chief executive with his pride intact. But it will perhaps be on a less celebratory note than when he left Ireland’s second-largest bank AIB in 2014, just after it had ended a long streak of losing money associated with the eurozone crisis.
Under Duffy, Virgin has in many ways undergone a more radical transformation than AIB. When he arrived at the firm in 2015, Virgin was not even known as Virgin but as Clydesdale Bank – a Scottish and Yorkshire-based group then owned by National Bank of Australia. Duffy demerged Clydesdale from NAB and listed it in 2015. In 2018, he and his bank then led an all-share merger with Virgin Money, which had in turn bought the remains of Northern Rock from the UK government in 2011.
Now, Duffy is selling Virgin Money (which he retained as the brand name for the combined group) to a firm led by a former longstanding Clydesdale banker – Debbie Crosbie, Nationwide’s chief executive since 2022 and who was previously Clydesdale’s chief operating officer under Duffy.
But the sale could be a disappointment for those who believed in Duffy’s pitch about how his bank could transform its profitability and consequently its share price on an independent basis.
Mid-tier M&A
The prospect of Virgin Money being swallowed up by an unlisted and mutually owned lender, moreover, will be a disappointment to some – including investors who bet on Clydesdale and Virgin’s ability to challenge larger lenders, perhaps partly by spearheading other bank M&A deals.
Virgin Money’s sale – coupled with that of Tesco Bank and the entry of Coventry Building Society into exclusive acquisition talks for The Co-operative Bank – shows that UK mid-tier bank M&A is materialising after years of waiting by financial institutions investment bankers.
But many previously thought Duffy’s end game might be a merger with TSB, owned by Spain’s Banco Sabadell – and which Crosbie ran as chief executive for three years after her 2019 exit from Duffy’s team.
Combining TSB with Clydesdale-Virgin could have created a newer addition to the top tier of UK banking, because Nationwide is arguably already in that top tier, certainly as a mortgage lender. Its balance sheet was £272 billion at the end of 2023, compared with £92 billion at Virgin Money and £48 billion at TSB. In mortgages, Nationwide will now be the country’s second-biggest bank after Lloyds Banking Group.
After the Tesco Bank deal, Virgin Money’s sale is the second acquisition by a much bigger bank in a matter of weeks.
It comes at a time of rising competition for deposit funding, thanks to higher Bank of England interest rates, and the end of the central bank’s small and medium-sized enterprise-focused term-lending scheme (TFSME).
Higher deposit funding costs, meanwhile, are less of a danger for bigger banks, thanks to larger market shares in current accounts and lower costs of wholesale funding – the latter also being a factor in an emergency capital injection into Metro Bank late last year.
Costs and regs
Importantly, costs are rising across the banking sector for things like anti-fraud and anti-money laundering, as regulators across Europe and the UK clamp down on those risks. Lately, investment in bolstering protection against financial crime has offset the benefit of other cost cuts at Virgin, in particular.
More widely, higher regulatory burdens make economies of scale even more important in banking nowadays – which is part of the point of the Virgin Money deal for Nationwide, as it adds to the latter’s bulk in current accounts as well as savings and mortgages.
Of course, big banks in the UK and elsewhere in Europe also have their share-price problems, notably Barclays.
That is again largely because of regulation – including on investment banking – as well as because their investor base is so reliant on the US, where there is a natural home-country bias in terms of risk perception, not to mention greater liquidity in the domestic stock market.
Virgin Money’s average deposit cost is 80 basis points higher than larger UK peers, according to estimates by Berenberg. As a result, it is less able to grow, and its return on tangible equity is substantially lower, too.
Late last year, it was still guiding for a statutory RoTE that was a couple of percentage points below double digits, the level the industry normally sees as the minimum for a listed bank to justify its shareholders’ risks.
As a result, Virgin money’s shares were trading at a 60% discount to book value before the acquisition announcement, compared to 0.6x book at Lloyds and 0.5x book at NatWest (whose share price has suffered recently for idiosyncratic reasons).
Risk and reward
Duffy’s strategy recently has been to boost net interest margins, as challenger banks typically do, by growing in higher-risk areas – in Virgin’s case in unsecured consumer credit and SMEs. Credit-card lending has grown especially rapid thanks to card partnerships.
This is part of the attraction for Nationwide, which needs to diversify from mortgages.
But credit cards and SME lending – coupled with commercial real estate – are today in the spotlight due to higher interest rates and the attendant difficulties of higher-levered borrowers to service debt. Higher credit costs in these areas could have removed any benefit of the boost to NIMs, attracting more attention from financial supervisors – and more concern among risk-averse equity investors.
For Nationwide, however, these risk dilemmas may be less of an existential problem thanks to its greater scale and above all because its mutual ownership makes the perceptions of investors (including those in the US) less of an issue.
Two decades ago, unlisted mutual and cooperative banks like the UK building societies seemed like a legacy of a bygone era, thanks to deals such as Bank of Scotland’s merger with the Halifax (now part of Lloyds) and Banco Santander’s takeover of Abbey National. Now it is almost the other way around.
Today, listed traditional banks increasingly look like the relics, something also potentially demonstrated by Coventry’s takeover of The Co-operative: transferring its ownership from private equity back to mutual status.
Venture capital-backed neobanks are valued on growth metrics rather than profitability. Mutual banks are not listed either, meaning less pressure to return capital to shareholders, something which is particularly acute when their shares seem to trade at a permanent discount.
Given the longstanding and often accurate perception that mutual banks tend to lag on technology compared with listed peers, Virgin Money’s aggressive digital-first strategy under Duffy may be another attraction for Nationwide.
For Virgin Money customers, however, mutual banks’ normally greater commitment to physical branches over listed rivals may come as some relief.
