CYBG surges on early Virgin Money progress, stronger margins

CYBG reported "good progress" with the integration of Virgin Money since completing the merger in October, with lending up and margins stronger than expected despite pressure from the highly competitive UK mortgage market.

Boosted by a strong pipeline coming into the first quarter of its financial year and good customer retention, group mortgage lending increased 1.5% to £60bn, helping group lending grow 1.4% to £71.9bn.

Lending to small and medium-sized business grew 1.2% to £7.6bn.

Annualised net interest margin, the key measure of a bank's margin between interest earned on money lent and paid on money saved, fell 20 basis points to 1.72% "due to sustained pricing pressure in the UK mortgage market". For the full year, NIM guidance was tightened up to between 1.65% and 1.70%, from the previous 1.60-1.70%

Capital levels remained healthy with a CET1 ratio of 14.5%, down 60bps due to dividend payments and distributions for Virgin's Luxembourg-traded AT1s, but well above minimum regulatory requirements of 11.6%.

The integration programme of Virgin Money since the deal was completed on 15 October has made "encouraging progress" on the initial stages of the three-year plan, with good progress on cost reductions so that initial milestones have been ticked off of underlying cost-to-income ratio in the first quarter below 60% and guidance increased to a minimum £150m of annual net run-rate cost synergies by the end of the 2021 financial year, versus £120m previously.

Chief executive David Duffy said mortgage lending growth for the full year will be lower as "market dynamics remain consistent with those experienced over the last 12 months and pricing in that market remains highly competitive", leading CYBG to focus on optimising "volume and value".

He was much more encouraged by the performance in SME, saying the bank was "well prepared for the start of the RBS Incentivised Switching Scheme and we hope to attract a large proportion of the 120,000 SME customers that RBS are required to switch", with an application submitted for a grant from the RBS Capability and Innovation Fund, "where we believe we offer the strongest case for delivering a genuine boost to competition in the SME market".

Complaints about historic PPI modelling were around 1,800 per week, in line with current provisions.

Shares in CYBG, having lost 50% of their value since August, soared 13% to 202.8p in early trading on Wednesday.

Analysts at Shore Capital, which has a 'buy' rating on the shares, said loan growth was tracking slightly better than forecast, with NIM guidance narrowed to top half of previous range and versus a consensus forecast of 166bps and impairments running at 22bps - broadly in line with consensus at 21bps.

The proforma core tier 1 ratio reduced by 60bps to 14.5% but "comfortably above" required levels and "implies circa £700m of surplus capital before management buffers are accounted for", versus a market cap of £2.6bn.

"On balance, we think this is a decent update which could drive modest upgrades to consensus, albeit maybe not so much for us given we are already top of the range. We therefore expect the shares to have a bounce following recent weakness."

Broker Panmure Gordon said that, while it has previously regarded CYBG as having similar challenges as the larger UK banks with "low returns, bloated cost base, legacy conduct costs, the expected cost synergies from the merger will significantly improve profitability despite our concerns regarding margin pressure at Virgin Money".

Moreover, the enlarged group will be "significantly overcapitalised" following the improvement in Virgin Money’s CET1 ratio following PRA approvals for mortgage RWA models in July 2018 and accreditation of IRB models for CYBG from FY2019.

Panmure estimate CYBG’s pro-forma 2021 return on tangible equity will improve to 11.6%, driven by the analysts' assumption that £100m of the £120m cost synergies identified by management will be recognised in that year.