Virgin/CYBG: Accounting for 0% credit card offers a concern

  • By Elizabeth Fry

The £1.7 billion takeover of Virgin Money by CYBG -  owner of Clydesdale and Yorkshire Banks - to create Britain's sixth largest bank makes sense because of the promised deal synergies. 

Once synergies are fully achieved in 2022, CYBG’s net profit is set to almost double to £673.9 million for that year, according to CLSA’s Ed Henning.

"The deal sees CYB better able to leverage its technology investment, add scale and likely benefit from an improved cost of funds," he said in a note. 

The one concern he has about the deal is Virgin Money's use of the effective interest rate accounting method (EIR) when booking credit card income. 

In essence, he explained, EIR allows lenders that offer cards with temporary interest-free periods to book in advance some of the revenues they expect to receive once the introductory period ends. 

Henning said credit card income and EIR accounting are major considerations when calculating the lender's income since almost one-third of Virgin Money's net interest income comes from credit cards.

Fully 40 per cent of that income is recognised through EIR accounting, according to the analyst.

"A result of this smoothing is that in the early stages more income is recognised than is billed, and vice versa in the latter stages." 

Booking income 

In his view, the practice of booking income that may not materialise is a concern and may create a headwind for CYBG.

That said, Henning likes the deal and is anticipating strong EPS accretion even before any revenue and funding synergies are realised.

But he can't ignore recent reports out of the UK that regulators are warning banks with high reliance on EIR accounting to consider holding extra capital to mitigate the risks. 

"It is expected that the Prudential Regulatory Authority will undertake a broader review of EIR accounting across the industry and is likely to include a focus on how behavioural risk impacts capital resources and requirements," added Henning.

Despite this regulatory backdrop, he went on to say, Virgin Money management remains confident about both their assumptions/methodologies and their capital position. 

Says Henning: "In the recent earnings results, management have been asked insistently around their credit card book, the EIR-accrued income, and the validity of their assumptions. 

“To these questions they have responded saying that they are “hugely confident” about their modelling assumptions given the richness and length of their data set and that the behaviour on their credit card book has been “very, very, very stable”.

Lawsuit for SME loans

The analyst also noted that CYB could be targeted in a class action seeking compensation on behalf of thousands of SME customers in the UK.

Press reports in December alleged CYB was served with a letter ahead of potential proceedings in 2018 alongside its former parent National Australia Bank asking for information about hedging products known as tailored business loans (TBLs).

“After doing some investigation around class actions, generally you get some seed funding with an initial claimant and then normally 3moths to 12moths to build a case finding more plaintiffs to obtain the second allotment of funding. 

“We are getting closer to the 12 month mark on the TBL class action and CYB has not received any formal legal action.”

CYB has been dealing with TBL claims for some time with a historical provision raised of £238 million for TBLs disclosed at the IPO. While some customers have already been compensated for the products.

Current customer redress provisions that include TBLs is £69million 

“Further when receiving compensation a claimant will likely sign a legal document prohibiting them from further action which will likely limit the potential pool of claimants.” 

Henning anticipates more media attention likely before July on this issue. 

While this is a potential negative sentiment issue the viability of the claim and potential financial implications are yet to be proven, we remain optimistically cautious.”