June 18, 2018 / 12:09 PM / a month ago

Breakingviews - Virgin Money is cheap bride in UK bank wedding

LONDON (Reuters Breakingviews) - Virgin Money has turned out to be an acquiescent bride. The UK lender on Monday agreed to wed larger CYBG in a deal worth 1.7 billion pounds. The agreement to create the UK’s sixth-biggest bank by assets comes barely a month after Virgin Money spurned an initial approach. A union may well make sense – but its shareholders are entitled to feel short-changed.

A man checks his phone as he walks past a branch of Virgin Money in Manchester, Britain September 21, 2017

There are plenty of incentives to get hitched. Pooled operating costs should create a lender better able to cope with a wobbly housing market and the economic consequences of Brexit. CYBG gets a large credit card book, while Virgin Money gets access to its partner’s low-cost deposit funding. Meanwhile, Virgin founder Richard Branson gets to splash his brand across a larger business.

Based on share prices before CYBG first declared its interest, the all-share offer values Virgin Money at a 40 percent premium, equivalent to 488 million pounds. That doesn’t look too stingy – until one considers that the merged entity has pledged 120 million pounds of annual cost savings by 2021. Taxed at 25 percent, these are worth about 900 million pounds in today’s money. Virgin Money shareholders are getting little more than half of that.

Yet if CYBG is getting a steal, its investors have yet to notice. Shares in the 2.7 billion pound group have fallen since it first declared its interest in early May.

Shareholders are right to have reservations about increasing their exposure to indebted UK consumers. Last July the Bank of England noted that the impact of borrowers’ ability to repay credit cards “was not always fully considered in firms’ assessment of risk”. Earlier this year, the regulator followed up with a letter to bank bosses about credit card operators which offer 0 percent interest rates to customers who transfer their balances from other providers. Some lenders are front-loading expected revenue from these deals, using an accounting method called the “effective interest rate”. Virgin Money booked around 13 percent of its net interest income in 2017 using this practice.

If those accounting assumptions prove too optimistic, then hefty savings give CYBG some room for manoeuvre. Virgin Money, meanwhile, might be grateful to be part of a larger family.

Breakingviews

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