Upstart challenger banks eye consolidation

challenger banks

Challenger banks are trying to rival the giants of the high street

‘Today represents a decisive moment when we take a step to a new banking system that works for Britain,” proclaimed George Osborne, the then-Chancellor of the Exchequer, on the day the Independent Commission on Banking published its final report.

It was September 2012 and the commission, which had been set up to examine how best to overhaul the banking sector in the wake of the financial crisis, had made a host of recommendations to the Government.

Its most eye-catching proposal was to force lenders to ring-fence their retail operations from their riskier investment banking businesses, to make banks safer in the event of another financial meltdown.

The commission, led by Sir John Vickers, a former chief economist at the Bank of England who had then led the Office of Fair Trading, also made a raft of other recommendations to boost competition in banking.

The commission declared that the consolidation after the financial crisis that led to the merger of Lloyds and HBOS had “impaired competition” in the UK’s banking sector. One way to rectify the problem was by tackling barriers to the entry and growth of smaller banks, it said.

Those barriers have indeed now fallen. The rules for new entrants were loosened by regulators in 2013 and as a result there has been an explosion in the number of challenger banks applying for and securing banking licences, looking to snatch customers from the “Big Five” high street giants of Barclays, HSBC, Lloyds Banking Group, Royal Bank of Scotland, and Santander.

The latest annual report of the Bank of England’s Prudential Regulation Authority, covering the year to the end of February 2016, revealed that it held 48 pre-application meetings with more than 25 prospective banks.

However, after the rapid expansion of the banking market, there is a growing belief that it will soon start to consolidate again. Investment bankers say the pressure on challenger firms to strike deals with each other is increasing, and last week analysts at the stockbroking firm Goodbody declared that M&A activity in the sector was “inevitable” to truly compete with the incumbent giants of the banking world.

The banking commission’s report in 2011 laid bare the scale of the task facing challengers: Britain’s four biggest banks accounted for 77pc of personal current accounts and 85pc of current accounts held by small and medium-sized enterprises.

Jayne-Anne Gadhia
Jayne-Anne Gadhia, the boss of Virgin Money

Talk of consolidation has been given new impetus by the troubles at Co-operative Bank, which has put itself up for sale. Many in the financial services industry believe the ethical lender will be broken up, and a host of challenger banks are eyeing bits of its business that they could acquire at a knock-down price.

The challenger bank sector ranges in size from bigger, more traditional banks such as Virgin Money, CYBG, TSB and Metro Bank to specialist lenders including Aldermore, Secure Trust and OneSavings, and fledgling digital-only businesses such as Atom, Monzo and Starling.

Even without consolidation, the ranks of the challengers could thin naturally. In March the smartphone app-focused firm Tandem lost its banking licence after its backer, the Chinese-owned store group House of Fraser, pulled a planned £29m investment.

Tandem, which planned to offer savings accounts, had been granted a licence to take deposits by the Bank of England only 16 months earlier. But it was contingent on the firm raising capital, appointing independent directors and establishing adequate computer systems within 12 months.

For the more established challengers, the problem is reaching sufficient size. Goodbody’s analysts said: “Banks will need scale to compete in the long run to drive down operating expenditure, funding costs, and to optimise capital positions – but, more importantly, to develop the scalable, sophisticated platform that is needed to serve customers well in a digital age. This will stimulate in-market consolidation.”

Deal-making is clearly already on the agenda. Last autumn, CYBG, the lender behind the Clydesdale and Yorkshire brands, submitted a bid to RBS to buy its 300-branch Williams & Glyn division. The ambitions of CYBG’s chief executive, David Duffy were scotched, however, after RBS, owned by the taxpayer since 2008, scrapped the increasingly problematic sale of the business in February.

Duffy is unlikely to be deterred for long. He told The Daily Telegraph in November that he believed CYBG was viewed as the “consolidator of choice” in the banking industry, suggesting he is clearly keen to do a deal.

David Duffy
CYBG chief David Duffy

Virgin Money’s chief executive, Jayne-Anne Gadhia, is also alert to potential deals, saying that she had “looked at literally everything in the market” after her bank’s transformational £747m deal to buy the bailed-out Northern Rock in 2012.

A potential catalyst for M&A among the specialist lenders is the private equity bid for the SME-focused bank Shawbrook. Pollen Street Capital, which founded Shawbrook and floated the business just two years ago, launched an £842m hostile takeover of the bank at the end of March with a joint bidder, BC Partners.

Some in the City believe that if the takeover of Shawbrook is successful, with BC Partners’ considerable financial resources behind it, the bank could set its sights on one of its rivals, such as Aldermore or OneSavings.

At OneSavings itself, chief executive Andy Golding, has already shown he is open to the idea of dealmaking. In March, he said he wanted the company to be “at the forefront” of challenger bank M&A and he was “always chatting” with peers.

Another potential consolidator is Joe Garner, left, the former chief executive of BT Openreach, who took charge of the mortgages giant Nationwide a year ago and is thought to be ambitious to leave his mark on Britain’s biggest building society, potentially via acquisitions.

If the banking sector does see the expected wave of consolidations, it will be deja vu for older bankers.

PwC noted in a report in March that “by 2010, 26 of the 32 banks and building societies which existed in 1960 were absorbed into just six major groups: Barclays, HSBC, Lloyds, Nationwide, RBS and Santander.”

This consolidation, and the problem with competition in UK banking that it created, was countered by the rise of the challengers. But the upstart lenders remain fragmented, and paradoxically, if any of them are to mount a genuine threat to Britain’s biggest banks, they must themselves consolidate.

[“Source-telegraph”]