What Virgin Money’s results tell us about the UK banking sector

Like the rest of the UK banking sector, this FTSE 250 lender has traded largely sideways for the past two years. Here are the key takeaways from its latest results.

A resilient results season for UK lenders ended in downbeat fashion today as Virgin Money UK (LSE:VMUK) revealed a more cautious stance on bad debts than the City had been expecting.

Shares in the FTSE 250-listed challenger bank fell as much as 11% as a mixed set of interim results included an impairment provision of £144 million, up from £21 million the year before and 12% higher than the market consensus.

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Positives from the results for the six months to 31 March included a 3% beat on net interest income of £855 million, a capital buffer of 14.7% and next month’s £45 million payment of an interim dividend of 3.3p a share, up from the City’s 2.5p forecast.

Virgin Money also expects further share buybacks, although this is subject to the early July outcome of the Bank of England’s annual cyclical scenario stress test.

The lender said today that the number of customers in financial distress remains low, but that it expects arrears numbers to increase as the credit cycle normalises. The forecasts driving its updated impairment provision include a base case for a 1.4% contraction in GDP in 2023, peak unemployment of 4.9% in 2024 and a decline in house prices across 2023-2025.

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Lending volumes in the most recent half year were stable compared to 2022, with strong business growth offset by the weaker mortgage market and prudence on unsecured loans.

Additional investment in the company's mortgage platform and inflation pressures meant a 5% rise in operating expenses, providing another reason for today’s share price weakness.

Underlying profits fell 16% to £312 million but chief executive David Duffy remains confident in 2024 targets as the company enters the second half of its digital-focused three-year plan.

Next year’s benchmarks include a cost-to-income ratio below 50%, return on tangible equity (RoTE) above 10% and significant further capital distributions as the company returns to a capital buffer range of 13%-13.5%.

The City is more cautious on next year’s RoTE, however, with the consensus closer to 8%. Ahead of today’s results, analysts at Jefferies had a price target of 197p while UBS stood at 220p.

The shares later settled 6% or 9p down at 144.15p, leaving them a fifth lower than where they were in early March prior to the turmoil in the wider banking sector.

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It’s been a similar story for other UK lenders, with Lloyds Banking Group (LSE:LLOY) down 13% over the same period despite yesterday’s reassuring first-quarter update.

The selling pressure reflects a market now primed to expect weaker loan growth and softer credit quality, as well as other headwinds such as mounting competition for deposits and higher wholesale funding costs given the sensitivities around tightening liquidity.

However, UBS analyst Jason Napier believes the market fails to appreciate the continued momentum in net interest income and that capital and liquidity positions are built to excess.

His near-term top pick is Lloyds, which yesterday beat expectations on pre-provision profit as it reaffirmed targets that Napier believes should be supportive of attractive shareholder payouts. UBS’s target price stands at 60p, compared with this afternoon’s 45.8p.