Virgin Money: conservative loan provisioning highlights risks

Bank investors are understandably a jittery bunch these days. So far the industry’s problems have concentrated in regional, deposit-dependent US lenders. But questions are being asked about smaller European banks as well, in particular UK retail lender Virgin Money.

Its share price, down 23 per cent this year, has trailed far behind those of larger banks such as Lloyds and the broader FTSE All-Share index. Virgin Money’s interim results on Thursday did not temper any frayed nerves, underscoring why the bank trades at 36 per cent of its tangible book value.

Higher than expected loan provisions caused a 6 per cent drop in its shares on the day. These came as a result of gloomy economic models that, unlike its peers, Virgin Money has not tinkered with since last September when a UK gilt crisis was under way.

That has meant more provisions, partly due to higher arrears on credit card lending, sliced £144mn from profit before tax at £312mn, 16 per cent lower than a year ago. Meanwhile, most of its UK peers have not substantially increased their cost of risk assessment.

There was some good news, namely an expansion of net interest margins alongside deposit growth. Virgin Money’s second-quarter NIM rose to 1.94 per cent, in line with its outlook, helped by rising rates. This is well below what Lloyds and NatWest earned in the first quarter. NIMs at both were more than 3 per cent. But Virgin Money managed to increase deposits, unlike its larger peers. These were £2.6mn or 4 per cent higher year on year compared with small declines elsewhere.

That Virgin Money is attracting deposits should be reassuring given its loan to deposit ratio is 108 per cent, on the high side compared with larger lenders. But these deposits presumably come at a higher cost given its relatively low NIM. Its share of buy-to-let lending — about a fifth of loans — is also high enough to keep some shareholders on edge.

Virgin Money has a conservative outlook and has provisioned accordingly. Those investors seeking a higher risk bet on UK banking will find its low valuation compelling, others may prefer more soothing choices.