Virgin Money (VMUK) struck a somewhat sombre tone when it released its full-year figures in November. The nominally favourable backdrop provided by rising interest rates had been clouded by persistent inflation and squeezed lending margins. The digital bank did placate shareholders with a £150mn share buyback, but it also prudently set aside another £309mn in expectation of a sizeable increase in loan defaults. Unduly pessimistic, perhaps, but we shall see.
The provision added ballast to the view that 14 successive rate hikes by the Bank of England (BoE) were finally dampening aggregate demand in the economy. This year, policymakers may have taken note of Begbies Traynor’s (BEG) recent Red Flag Alert for Q4 2023, which showed that 47,477 companies were in acute financial distress at the end of the year.
Admittedly, the BoE’s Monetary Policy Committee (MPC) has been in an invidious position as it has been attempting to keep a lid on prices without tipping the economy into a prolonged period of stagflation. Central bankers rarely get any sympathy for their handling of the economy, but it was an impossible balancing act. UK inflation remains well above the 2 per cent target rate, which is why a retracement in borrowing costs has yet to begin: last week, the MPC voted by a majority of six to three to maintain the existing rate.
Oddly enough, just as Begbies Traynor was hoisting the red flag, it was revealed that the S&P Global purchasing managers’ index (PMI) for January came in at 52.9, up by 80 basis points from the prior month and in advance of initial projections (readings above 50 points denote expansion in the economy). The improvement was particularly noticeable in the all-important services sector, which accounts for 81 per cent of total UK economic output.
We’ve become all too familiar with conflicting signals on the economic front, but Virgin Money’s first-quarter update for FY2024 appears to support the PMI analysis. Margins have stabilised since its September year-end, and it detailed positive outcomes relating to new accounts, deposit rates and business lending.
You could argue that there are mixed messages in terms of the group’s unsecured lending. In monetary terms, this increased by 2.8 per cent through the quarter to £6.7bn, with growth in this corner of the market driven by credit card lending. It’s estimated that around 5.7mn low-income households have unsecured debt, and there can be little doubt that credit card liabilities have increased to meet regular household bills as opposed to discretionary spending. The Joseph Rowntree Foundation estimates that the annualised cost of financing the unsecured debt is around £3.9bn, or £680 per household on average, representing a 45 per cent increase on the financing costs seen before the BoE started cranking up the base rate.
Nonetheless, Virgin said that repayment rates have been stable, and management has “continued to observe customer behavioural activity outperforming our prudent assumptions across spend, repayment and retention, resulting in [effective interest rate] performance remaining persistently better than expected”. Credit card arrears have increased in line with expectations, but the group seems content with the quality of its loan book, even though the overall expected credit loss increased by 7 per cent from the final quarter of 2023 to £578mn.
On balance, management’s prudence seems justified given the still uncertain economic backdrop and its influence on consumer sentiment. It hasn't shied away from rationalisation measures, warning of job losses and branch closures. The group’s average liquidity coverage ratio came in at 150 per cent, while the net stable funding ratio stood at 135 per cent over the same 12-month period. The group reduced its Term Funding Scheme liabilities by £1.2bn to £5.1bn, meaning that it has now repaid all its maturities due in 2024.
On review of Virgin’s update, you’re left with the impression that the group is holding its own on the back of “resilient credit card spending and robust business activity levels”. However, it does seem slightly counter-intuitive when set against Begbies Traynor’s revelations.
But statistics indicate that the aggregate gains from higher savings rates have outweighed the extra burden of debt interest. Indeed, Simon Pittaway, senior economist at the Resolution Foundation, notes that the scenario is “completely unprecedented in recent history: net interest income typically falls when rates rise”. The increase partially reflects a relatively slow pass-through to mortgage rates: it takes time before mortgagees are forced onto variable rates. We are likely to witness a more negative turn by the time the MPC starts chipping away at the base rate, at which point you should be loading up on suitable equities.
