In Brexit Britain, It's Survival of the Fattest
(Bloomberg) -- Britain's big four banks, branded dinosaurs by the many upstarts that have sprung up since the crisis, were supposed to be extinct by now. Yet with Brexit around the corner, their bulky balance sheets and dominant market share are proving hard to kill.
Judging by the latest proposed pairing of two challengers -- CYBG Plc and Richard Branson's Virgin Money Holdings U.K. Plc -- the pressure to evolve is squeezing the fittest, not the fattest. As such, a low-ball bid may not need much upping to be accepted.
CYBG's proposed 1.6 billion-pound ($2.2 billion) all-share bid for Virgin Money is worth about 15 percent more than the target's closing share price on Friday. That premium doesn’t look overly generous given the potential for future cost savings and growth.
There's a whiff of opportunism here. Virgin is too small and the market knows it: over the past 12 months, analysts have cut their earnings expectations for the next two years by more than 12 percent.
The lender has been struggling to compete in a saturated market -- even with a target of just 3 percent of the U.K. mortgage market. An end to the Bank of England's cheap cash may double Virgin's marginal cost of funding and price it out of prime lending, according to Berenberg analysts. Higher loan losses after Brexit would erode profit further.
A tie-up would bring together Virgin's credit-card and mortgage loan book with CYBG's bigger exposure to small businesses and access to cheap checking-account deposits. Acquiring Virgin would double CYBG's loan book to nearly 70 billion pounds and take out a rival eyeing expansion online and in services for small businesses. Bloomberg Intelligence estimates about 10 percent of the combined companies' expenses could be cut, too.
But while bigger is better, there's not much of a sense of victory here. A combined Virgin-CYBG would still have an excess of loans to deposits and would rely on cheap central-bank funding for about 12 percent of loans, according to UBS.
Then there's the IT challenge. Together, the two banks invest about 500 million pounds, according to Bloomberg Intelligence. Even if the combined business can rationalize some of that spending, it will still eat into profit. TSB Banking Group Plc's recent woes highlight the ever-present risk of IT disasters. If a deal comes to pass, there will be plenty to distract management before the big incumbents will feel the squeeze.
So far, the dinosaurs are reaping the benefit as Brexit looms. They have enjoyed some of the biggest upswings in price-to-book value rather their smaller challengers. Not all banks are equally healthy -- but the ability to absorb loan losses while investing in technology is probably easier for the big four. Until a big tech brand like Amazon makes a frontal move into finance, or fintech brands really gain traction, it will be the fattest who survive.
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