Unsurprising news from UK challenger banks this morning, as CYBG has made a £1.6B all-share takeover offer for Virgin Money (a 15% premium to VM’s market value). The deal structure (i.e. full share, no cash, small premium) raises a question whether new financial upstarts, that sought to challenge the UK’s Big 4 banking titans, stand a chance to steal any meaningful market share within the gruelling financial sector environment on their own. Paragon Banking also confirms that it is in the early stages of considering a possible acquisition of Titlestone.

The young upstarts sought to disrupt entrenched power of established UK banking institutions through use of information technology and more modern branding strategies, but rising costs, tough regulatory requirements and steadily rising competition have already resulted in some sector consolidation. This was initially evidenced by South Africa’s FirstRand mixed cash/shares takeover of Aldermore in 2017, and the newest CYBG/VM deal adds further fuel to the fire of the idea that the challenger banks will not be able to survive on their own despite several years of exciting growth prospects.

High overheads to retain a banking license and the end of Bank of England’s bank funding schemes earlier this year mean that it may make sense for sector rivals to combine their resources to improve cost efficiency. With UK economic growth disappointing as of late (i.e. soft inflation and wage growth, smaller GDP rise) and challenger banks’ further growth opportunities in doubt, is more industry consolidation inevitable?

Could Metro Bank or OneSavings Bank be next in line for M&A interest (perhaps even from abroad, now that GBP is in a weak position, making cross-border M&A attractive)? Metro is already suffering from poor capital adequacy (CT-1 fell sharply to 13.6% in March), and there is currently added impetus to shore up the challenger banks’ balance sheets through integration.

Artjom Hatsaturjants, Research Analyst, 8 May 2018