challenger valuation due to its challenging outlook

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Bank of England governor Andrew Bailey this week warned the market not to expect interest rate cuts soon. He might rethink that hawkish tone if he studies Virgin Money’s full-year results, given that its customers are under stress. Profits for the high street lender were a fifth lower than expected and will disappoint in 2024 as well.

This revealed the stress among Virgin Money’s customers. Higher UK interest rates no longer provide Virgin Money with the net interest income boost they once did. Instead, the challenger bank had to lift its loan provisions to meet its own muted economic expectations. Virgin’s shares dropped as much as 8 per cent.

Higher than expected new provisions of £165mn in the second half mean full-year credit provisions climb to 42 basis points of total loans, up six times over last year. Worrisomely, this pertains to Virgin’s credit card business as signs of consumer stress appear. In this way, boosting loan loss reserves is sensible.

Shareholders lose out. Returns on tangible equity will drop to 8 per cent next year, instead of the double digits promised previously. Yet dividing its price/tangible book by the price/earnings ratio reveals that the market had already priced in that fall.

Virgin Money does not see this coming from lower NIMs, guiding for between 190bp and 195bp next year, slightly up on 2023. Deposit competition is the obvious risk to margins. Virgin’s challenger status means it already pays up compared with the market and will continue to do so.

That confidence — and a 60 per cent discount to book value — explains the bank’s generosity with shareholders. It plans £150mn of buybacks. This moves common equity tier one ratio down to 14.1 per cent, leaving another £160mn on top of CET1 targets, says Citi. With expected dividends, the bank offers a forward yield of 14 per cent.

But the bank’s largesse with shareholders did not lift the share price. Virgin Money’s conservative stance on the economy is well founded, as is the market’s caution with the shares.