The chief executives of three of Britain’s leading challenger banks – Paul Pester of TSB, Craig Donaldson of Metro Bank and David Duffy of CYBG – like to get together over dinner every so often to compare notes on what it is like locking horns in competition with the big five lenders.
Dinner will surely be on Mr Duffy next time the three get together.
Mr Pester is fighting fires following TSB’s catastrophic move to a new IT platform while Mr Donaldson has been having to soothe the feathers of shareholders ruffled at Metro Bank’s multi-million payments to a company owned by the wife of its founder Vernon Hill.
Mr Duffy, by contrast, has spent the last few weeks negotiating a takeover of Virgin Money by CYBG, owner of Clydesdale and Yorkshire Banks, to create Britain’s sixth largest lender.
That he has done so without having to sweeten his offer to Virgin Money’s shareholders will be a cause of celebration in itself.
The reasons for the two banks coming together is straightforward.
Image: The Clydesdale name will disappear in favour of Virgin Money under the takeover plans. Pic: CYBG
The rising cost of regulation and of maintaining high street branches, along with the likelihood of higher interest rates, price wars in some products sparked by the incumbent banking players and the end of schemes put in place by the Bank of England to stimulate lending following the crisis mean the competitive landscape for the challenger banks is getting tougher.
Added to that are changes to the way customers are using banks and, in particular, switching to digital solutions.
The sector is facing huge disruption from numerous fintech players who threaten to destroy the profitability of the traditional banks.
There are specific benefits from these two players joining forces.
One, part of a deal with Sir Richard Branson’s Virgin Enterprises, is that CYBG gets its hands on the Virgin brand – which enjoys high levels of awareness and popularity among customers. Over time, all of the branches will be rebranded Virgin Money.
Another benefit is greater market shares in some product areas. Both banks offer mortgages and savings accounts but CYBG has no presence in investment products or in the credit card market, where Virgin Money does.
Similarly, Virgin Money has no presence in providing banking services to small and medium-sized enterprises (SMEs) while CYBG does. The merger also creates a national business: at present CYBG has fewer than a dozen branches in England outside its Yorkshire heartland.
Another benefit is that, with some £425m worth of funding from Royal Bank of Scotland available to help increase competition in the small business banking market, the combined CYBG-Virgin Money will be in a stronger position to bid for some of that.
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Cost savings will also be probably more than the £120m stated by the bank.
Virgin Money was developing a new digital banking operation that will no longer now be needed – but those saved development costs have not been included in any sums published by CYBG.
Yet there will be concerns over the deal, leaving aside job losses, which will naturally arise as duplicated roles are taken out of the business.
The first is the significant proportion of Virgin Money’s credit card book that is on zero-rate balances.
The Bank of England is growing increasingly concerned about the risks to lenders as customers abandon zero-interest credit card offers earlier than expected.
The way in which income from such products is accounted for is called the Effective Interest Rate (EIR) method, under which, banks that offer temporary interest-free periods may book future revenues they expect from those products after the interest-free period ends.
Those revenues will be in jeopardy if customers walk away after the interest-free period and, in Virgin Money’s case, such revenues accounted for around £160m in the last year.
The riskiness of such accounting assumptions was seen as seen as having strengthened CYBG’s hand during the negotiations – but that book now becomes the latter’s problem.
The second concern, in the wake of the TSB debacle, is the migration of Virgin Money’s customers to CYBG’s digital banking platform.
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CYBG was at pains to play down these worries today, arguing it has already migrated two million Clydesdale and Yorkshire Bank current accounts onto its new platform during the last three years, while insisting this would be a less complex integration than some other recent ones in the sector.
Debbie Crosbie, CYBG’s chief operating officer, pointed out that the migration would be phased over three years, rather than a ‘big bang’ as TSB attempted, which ought to minimise risks.
She also noted that many of Virgin Money’s 100,000 or so existing current account customers also currently have no access to digital banking in any case and highlighted recent big IT projects on which the bank had undertaken, not least its separation from National Australia Bank, its previous owner.
She added: “We are very alive to the challenge of managing execution risk. I and my team feel very confident – but not complacent – that this programme of work is very manageable.”
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Once upon a time, confronted with a banking merger, shareholders would worry more about the balance sheet strength of the combined bank.
It says much about the banking landscape, in the wake of TSB’s problems, that they are now more concerned about the migration of customer accounts to a new IT platform.