Don’t feel too sorry for Richard Branson after the crash of his Virgin Galactic spacecraft the other week; he should be quids in after the Virgin Money finally IPOs on Thursday. Virgin Money was founded out of the ‘good bank’ remnants of Northern Rock whose collapse kicked off the 2008 global financial crisis.
IPO cancelled then rekindled
Virgin Money cancelled its stock market listing in October because of volatile market conditions and uncertainty surrounding a change to Bank of England capital requirement rules.
Markets are back at multi-week highs and Virgin Money looks well positioned to meet the new BoE leverage ratio, so the IPO is back on.
The leverage ratio of Virgin Money was 3.8% as of October 31st so the new Bank of England requirement for bank capital to equal to 4.05% of assets by 2019 should easily be achievable with minimal capital raising efforts.
Initial valuations for the company were around £2bn but that has been moderated to the bottom end of a price range of 283p to 333p per share; putting the valuation closer to £1.25bn.
Taking on the top four banks
The UK banking industry is a difficult nut to crack for new entrants; the ‘Big Four’ banks; Royal Bank of Scotland Group PLC (LONDON:RBS), Lloyds Banking Group Plc (LONDON:LLOY), HSBC Holdings Plc (LONDON:HSBA) and Barclays (LONDON:BARC) dominate with around three quarters of all current accounts.
Multiple surveys have shown that people in the UK on the whole distrust even dislike their banks but this has bred an apathetic opinion that all banks are just as bad so account-switching is rare.
Virgin Money, Aldermore, Tesco Bank, Tsb Bnk Grp (LONDON:TSB) and others have been given the title “challenger” banks to challenge the status quo in banking. To challenge the system, Virgin Money must break the mould of the distrusted bank but financial products can only vary so much.
Current accounts are the key
The advantage that the market incumbents have is that banking customers typically have all their financial products under one roof and that tends to be where they have their current account.
It is for this reason that Virgin Money teamed up with Tesco to lobby regulators to force the industry into mandatory monthly charges for current accounts, the theory being that customers would start to shop around more if being charged. Charging for current accounts would be unpopular and appears unlikely to ever become a reality.
Virgin Money has seventy-five branches but at the moment only customers in Northern Ireland and Scotland are offered current accounts. The bank desperately needs to increase the availability of its current account offering for the positive influence it will have on the growth of its other more profitable product lines such as mortgages and insurance.
Drop in mortgage applications a threat
CEO Anne Gadhia listed mortgages as one of the main revenue-drivers for the first half of 2014 but with new stricter regulations from the Bank of England and expectations of an interest rate hike next year; official statistics show mortgage applications have slowed.
Virgin Money must rebalance their customer asset mix but until the bank can expand its current account offering it remains heavily reliant on mortgages.
A play on UK economic growth
The growth of Virgin money will be closely tied to the growth of the UK economy; the more the economy expands the more demand there will be for credit and financial products. Even if Virgin money can’t expand market share against rivals banks, during a period of strong economic growth a rising tide lifts all boats.
A bank without the fines
For the investor who wants exposure to a growing UK economy through the banking sector, Virgin Money offers an alternative to the big banks without the uncertainty of legacy regulatory fines.
The tightening regulatory environment inside the banking industry means some larger banks are trying to shrink their loans book so challenger banks like Virgin Money can step into that breach.
Is TSB a template for Virgin Money?
TSB floated on the London Stock Exchange at 260p per share in June and quickly climbed to over 290p in its first day. In the three month’s ending in September, TSB’s pre-tax profits increased almost 30% on the same period last year and also secured almost 10% of new current accounts opened during the period.
Although it has its differences, TSB is in a similar position to Virgin Money so it should be of some concern that despite its solid first day of trading and strong earnings, its shares are trading back down at 271p.
Since the end of the first day of trading; the movement in TSB shares has correlated to industry peers but TSB shares are actually underperforming the ‘Big Four’.
Line chart of TSB and ‘Big Four’ share prices since the TSB IPO
Virgin Money is in a great position to take advantage of a growing UK economy and customer dissatisfaction over the Big Four banks is an incredible opportunity to reshape banking and take market share. The risk is that in the short term, the lack of current account and reliance on mortgages means investors may still favour owning shares in the big banks that are coming off a low base since a bout of regulatory fines.
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