With both the Lloyds Banking Group 624 branches and the Northern Rock 70+ branches on offer, the Northern Rock option seems the smarter move for Virgin Money.
The key difference between the two deals is the amount of capital that will be required to make the deal work and the time it will take to break even.
With Verde there is a misbalance between loans and deposits, with far more loans than deposits. This means that whoever gets the deal will need to find somewhere around £30bn of bridging capital. With capital costing an all-time high this could prove to be very expensive and, as a result, significantly extend the payback period for the deal.
With Northern Rock the misbalance is the other way round with more deposits than loans. For a business that is focussed on lending, as Virgin Money is, this is the perfect situation. Having access to low cost funding, i.e. customer deposit balances, will enable the acceleration of the growth of loans. In addition Virgin Money would get 70 branches, which is sufficent to provide a high street presence, but not such an overhead as 624 branches. Ultimately not having too many branches is going to be an advantage since the fall off in both sales and servicing through branches is continuing to accelerate due to greater use of internet banking, call centres and mobile banking. As branch-based servicing and sales drops then branches become increasingly expensive to run, increasingly irrelevant and more importantly a drag on the business.
Whoever acquires Northern Rock is going to have to invest significantly in the Rock's digital presence. The current internet offering is basic and outdated at best, and does not provide a good customer experience. This is where Virgin has real strengths with both its focus on delighting customers across all its brands and its investment in new technologies including the internet and mobile. By combining the assets and experience of Virgin Mobile, Virgin Media and creating a rewards programme based around the other Virgin offerings, such as Virgin Atlantic, Virgin could be position itself as a truly different alternative to the traditional banks, particularly as there is increasing convergence between the banking, telco and payments industries.
Whilst much has been spoken and written about the airline-style branches that Virgin will open, it will be the creation of this experience in the digital world that will increasingly be key to the success of Virgin Money as a bank. Having a differentiated digital strategy for the bank defined including what the digital experience with the human touch is going to be is going to be critical to compete.
A second critical requirement will be speed of execution. The buyer of Northern Rock will have significant potential time advantages over the buyer of Verde, which will need to be exploited. Verde is undoubtedly far more complicated to execute with the separation from Lloyds Banking Group and the integration into the buyer's infrastructure. This will be a multi-year, complex programme. For the buyer of Northern Rock, there will be no mother ship to separate from , it is a far simpler organisation and therefore, whilst not being completely straightforward, it provides the opportunity to be out in the market with the new differentiated offering for some considerable period of time before the new Verde can be launched.
The undue haste with which the Northern Rock sale is being rushed through, in parallel to the Verde disposal, also makes the deal better for the buyer. With bank valuations having crashed and two eager sellers it is a buyer's market, so whoever buys Northern Rock is going to be able to purhase it at a keen price and is unlikely to pay any more than £1bn, around two-thirds of what the Government had been expecting to receive.
Of course Virgin Money is not the only organisation seeing the true potential of the acquisition of Northern Rock . JC Flowers, backed by funding from CIC, the Chinese state investment fund, is a serious contender. With Kent Reliance Building Society as their foundation for financial services in the UK, JC Flowers does have experience of the UK market, however, on the face of it, is not as well placed as Virgin Money to compete against the Big 5 banks should they win. However JC Flowers is no pushover when it comes to doing deals. It should be an interesting contest with a lot to play for.
For Virgin Money buying Northern Rock could be the transformational deal that could turn it into a real contender.