New year, new banks

Rainmakers and regulators

At the start of 2012, national branch networks remain on the block – and it isn’t just the usual suspects bidding for them. SHAYLA WALMSLEY reports on the potential upheavals around the corner.

Two current trends will have a significant impact on the UK high street banking market in 2012. The first is the entry into the market of upstarts promising to renew public faith in retail banking with an all-new customer service offering. The second is another wave of regulation, principally the Independent Commission on Banking’s (ICB) recommendation that banks ring-fence their retail banking businesses and meet capital ratio obligations higher than those set out under Basel 3.

It isn’t yet clear how either of these trends will pan out. But some “known knowns” are emerging. The first is that you don’t need to be a bank to buy one – but you do need scale. Virgin Money reckons it will have four million customers following its RBS-financed £1.1bn acquisition of Northern Rock – though, of course, it left the toxic Northern Rock Asset Management in state hands, along with NRAM’s £20bn debt to the Bank of England.

Until now, the firm has grown its UK business online and via direct marketing. Now it has a banking licence, it is looking for branches. “Acquisition is not the be-all-and-end-all but it will take longer to reach scale against the Big Five banks without a branch network,” says a source at the bank.

Virgin Money faced competition from NBNK, a venture set up to acquire sufficient branch and other assets to take on the incumbents. NBNK is also bidding against the Co-operative Bank for the 632 bank branches European regulators have required Lloyds to divest via Project Verde.

Yet it’s an inopportune moment for an opportunity, at least from the seller’s perspective. “Not least because they’re pricing the business now for what it will be worth in a couple of years’ time,” says a source close to the Lloyds sale process. “We know what the business is worth but others might undervalue it because of turbulent market conditions.”

With reportedly lower-than-anticipated bids so far for the Verde portfolio (NBNK offered £1.5bn, significantly below book value), and with some initial would-be bidders pulling out of the process because they have been unable to secure funding, Lloyds is progressing both a trade sale and an initial public offering (IPO) in order to maximise the value if it gets the business.

“No-one would want to sell a chunk of their business or to lose their customers,” says the source, “but we’ll still be a formidable force after the divestment. That will be the point at which the past is finished. We’ll be able to close the door on it.”

Behind that assertion is the bank’s plans to revive Halifax – itself a challenger brand a few years ago – though it isn’t clear what impact the departure of CEO Antonio Horta-Osorio will have on those plans.

What happens after the divestment is open to debate. One of the Cooperative Bank’s obvious advantages is that its existing branch network would make it easier to absorb additional ones. Virgin Money, which has plans to list its new bank within five years, claims its Virgin Money Stores (named to exploit brand recognition without the popularly perjorative “bank”) will avoid the problems Santander faced when it acquired 318 RBS branches last year because it will not need to migrate existing product lines.

CEO Jayne Anne Gadhia has pointed out that there’s little overlap between Virgin credit cards and Northern Rock’s £14bn mortgage book. And she insists the taxpayer won’t lose through the sale of Northern Rock, despite the gap between Virgin Money’s £747m cash acquisition and the £1.4bn to rescue the struggling bank.

The deal has been widely criticised by those who say it implies a loss to the taxpayer of some £400m. “I can understand the way it’s being put,“ says Ms Gadhia, “but at the end of the day the Government is going to over-deliver on their promise.”

Tesco Bank’s example may be instructive here. The supermarket bank offshoot has delayed the introduction of a mortgage product, originally scheduled for launch this summer, until early 2012, to ensure its back office is up to scratch. It’s likely to launch a current account at around the same time.

Even if the bids for branches don’t work out, not all of the potential new entrants will simply disappear. Virgin Money, for instance, intended to buy corporate structures with banking operations had its bid for Northern Rock not been successful. In contrast to Australia, where it launched a credit card with Macquarie and retail banking services with Citi, and South Africa, where it operates via a joint venture Absa, in the UK the firm plans to go it alone.

But assuming that one or more of these upstarts opens up on the UK high street, it’s unclear how much they’ll change the banking industry. Santander – though not an upstart in the way that Lord Levene’s fund manager-backed NBNK vehicle is – arguably just made the high street’s Big Four banks into the Big Five.

Branches under new ownership won’t necessarily be offering significantly new products. The Lloyds source reckons there’s an immediate opportunity for the purchaser to upscale by expanding the range of products currently sold in the164-branch C&G portfolio. Yet Lesley McLeod at the British Bankers’ Association (BBA) points out that, although new entrants have the potential to drive innovation, and existing mature players are confident they’ll be able to innovate to meet the challenge by exploring niches and different ways of delivering products, all the competitive advantage at the moment is around quality of service.

In short, although none of the new entrants has ruled out the launch of new products, they’re capitalising on customer discontent with the customer service offered by incumbents. Tesco Bank, for example, offers what one observer describes as “straightforward” products in a market characterised by complexity and poor customer service.

“Getting customer service right will be the core differentiator,” says the NBNK source. “In one form or another, the other banks have fallen short – whether that’s because they’re offering inflexible terms, or they’re unresponsive to complaints, or a lack of staff knowledge, or fees are too high, or they’re employing hard-sell tactics. The NBNK product suite will be the best in class but the differentiator will be customer service.”

Virgin Money’s source likewise points to strong brand recognition and what it claims is a competitive advantage in outperforming incumbent banks in the one area that matters to customers. “We can’t compete on the rate for a loan, but the Big Five banks [including Santander] are not doing that well,” he says. “People will look for more than the product when there are only a few basis points between banks.

Regulation from all sides

Even if new entrants won’t necessarily change the contours of the UK market, regulation will – and both incumbents and challengers will be facing more of it from all sides. “Hardly a day goes by without another twist in the regulatory plot,” says PwC partner Kevin Burrowes. “Bank executives are still trying to work it out.”

One likely unintended consequence of the requirement that banks hold more capital against specific parts of the business is, perversely, that less money will be available for lending. “It depends on how ring-fencing works,” says MacLeod. “It isn’t clear where the lines will be drawn but when [the government comes] to draw them, it needs to get them right. The danger is that UK banks will be at a competitive disadvantage against overseas banks if there are gold-plated regulations and banks that have already recapitalised and restructured have to do yet more on top.”

In fact, BBA CEO Angela Knight goes further in a recent blog post, claiming banks could lose benefits of diversification, and that a ring-fence could work against financial stability because it would encourage an existing tendency among high street banks towards pro-cyclical lending.

Burrowes points out that ICB calculations are based on amended – and outdated – Basel 2 numbers: “None of the regulators seems to have done any thinking about how the various regulatory strands will fit together. It’s still in motion and the regulatory environment hasn’t settled sufficiently for there to be clarity on what the consequences will be for UK Bank plc.”

The ICB report covered not only ring-fencing and capital ratios but also increased competition. The third could be a result of the first – a redrawing of the boundaries as some UK banks decide to pull out of some businesses while others move into them.

“Banks will be trying to understand the business economics and deciding whether they want to maintain a presence in some markets and business areas or whether they want to pull out of them,” says Burrowes. “At the same time we’re talking to a number of clients who have looked at the changing UK landscape and see it offering significant opportunities. The ICB is designed to increase competition and to improve transparency. That will happen over the next few years.”

Sticking to the script may well suit incomers such as NBNK. Earlier this year, announcing its UK specific strategy at a time when “conditions are right for the establishment of a new UK retail and SME bank”, it ruled out overseas expansion in the short term. Although it intends to add a retail wealth management business – a kind of middle-class private bank – to the high street banking business, it said larger UK banks had typically “suffered” from overseas expansion and involvement in more volatile business areas such as investment banking.

SHAYLA WALMSLEY is a business journalist.

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