Big banks face new threat from the ghost of Northern Rock

Customers queue to enter a branch of British bank Northern Rock
Nearly 20 years after the financial crisis, size and scale are once again in favour despite regulators' attempts to cut big lenders down - AP Photo/Sang Tan

Snaking queues outside Northern Rock have become the enduring image of Britain’s financial crisis. Now the ghost of the old lender threatens to haunt the country’s banks yet again.

Nationwide’s proposed £2.9bn acquisition of Virgin Money, which includes the remnants of Northern Rock, threatens to reshape the financial services sector and challenge the dominance of Britain’s six biggest lenders.

The deal will create a new banking powerhouse, with total assets of £366bn and a lending book worth £283bn. The combined group would become the second largest provider of mortgages and savings in the UK.

It would give Nationwide a seat at the top table alongside Lloyds Banking Group, Barclays, Natwest and HSBC.

Nationwide chief executive Debbie Crosbie has promised that the institution will remain a mutual once the deal closes in a rare example where a building society is the predator rather than the prey.

Member-owned lenders have long been considered the sleepy cousins of more hard driving banks.

“A combined group would bring the benefits of fairer banking and mutual ownership to more people in the UK,” Crosbie said after unveiling the deal. “We believe the combination would create a stronger and more diverse business that will be better placed to deliver value to our members and customers, both now and in the future.”

Debbie Crosbie, CEO of Nationwide Building Society
Debbie Crosbie, chief executive of Nationwide, said the deal would create a stronger and more diverse business - Stefan Rousseau

For Virgin Money, it marks the end of a journey that has seen the company evolve from a small credit card business founded by Sir Richard Branson to a large FTSE 250 lender.

Virgin Money was founded in 1995. In 2011 it bulked up after buying the healthy bits of Northern Rock, which was once a mutual, following the nationalisation of the stricken lender.

The sale was part of government efforts to create more competition in the banking industry, which has long been dominated by a small number of lenders.

However, challenger banks, building societies and fintech start-ups failed to make much of a dent in the market share of the country’s big four banks.

Benjamin Toms from RBC Capital Markets says: “The only place where there has been slight disruption is in the fintech space but when it comes to your main banking relationships – where your salary gets paid into – no one has really managed to shake the big banks yet.”

Nearly 20 years after the financial crisis, size and scale are once again in favour despite the fact that regulators and politicians spent years trying to cut big lenders down.

Higher interest rates have allowed banks to make bigger returns on their deposit base. The bigger the base, the bigger the profits. It has triggered a race to bulk up.

“When rates were low it wasn’t clear whether UK banks were struggling because of these low rates or because of structural problems in the UK,” says Toms. “Now rates have gone higher, it’s clear that scale is very important in the retail banking business.”

The Virgin-Nationwide tie-up comes hot on the heels of Barclays’s plans to buy Tesco Bank for £500m, a deal announced in December.

Coventry Building Society, another mutual, is also in talks to merge with the Co-operative Bank to create a supermutual with £90bn of assets. (Despite using the Co-op brand name, the bank is not a mutual society and is owned by a consortium of hedge funds following a 2013 rescue.)

In a sign of the difficulty posed by being a smaller challenger, Sainsbury’s Bank has also announced plans to wind down its operations, prompting speculation another lender may swoop in to acquire customer accounts.

“Challenger banks never really managed to make big inroads into the big UK banks organically, and therefore it seems like the only way to really use their muscle is through M&A, particularly given where valuations are today,” says Toms.

The valuation of UK banks has halved from their historical average, according to Shore Capital. Whereas in the past, banks were valued on a price to earnings multiple of eight to ten times they are now trading at between five and six times. It means there are good deals to be had for lenders looking to buy rivals.

Shore Capital analyst Gary Greenwood says: “You have got subscale operators that are struggling to earn a decent return. So it’s a combination of valuation and trying to improve the profitability of the subscale business.”

Other challenger banks such as Metro Bank have often been flagged as possible takeover targets, with Lloyds and Shawbrook named as possible suitors.

Specialist lenders saw their share prices jump on the back of the Virgin Money takeover announcement on Thursday, with OSB Group and Close Brothers both rising.

The deal gives Nationwide huge firepower to compete against the UK’s big banks, especially on mortgages where Virgin Money will add a £57bn portfolio.

The deal will allow Nationwide to leapfrog Natwest to become the UK’s second largest provider of mortgages and savings behind Lloyds.

In total, Nationwide and Virgin Money will have a 15.7pc share of the mortgage market versus 12.7pc for Natwest, according to RBC Capital figures. Lloyds, which owns the Halifax building society, has a 18.7pc share.

The tie-up also nudges Santander out of the top five banks by deposit base. Adding Virgin Money’s 6.6 million customers means Nationwide will usurp the Spanish lender’s position, with just over 11pc of the UK market.

Breaking into the top four will prove more difficult: Lloyd’s, Barclays, HSBC and Natwest have a near-70pc share of UK deposits.

Perhaps the way to do it will be more dealmaking.

“What it does highlight is that it’s very hard for smaller challenger banks to break into the UK banking space in a meaningful way,” Greenwood says.

Despite the push for more competition, the big six lenders — Lloyds, Nationwide, Natwest, Santander, Barclays and HSBC — still control around 80pc of the mortgage lending market.

While this may ring alarm bells, analysts at Citi say the market remains “highly competitive”, given that eight in ten home loans are sourced from mortgage brokers who can shop around to get customers the best deal.

Meanwhile, the Virgin-Nationwide deal represents something of a full circle for the ghost of Northern Rock. It will once again be a mutual.