Virgin Money bid sparks British bank consolidation talk

By Lawrence White and Sinead Cruise

LONDON (Reuters) - British entrepreneur Richard Branson, founder of the Virgin business empire, is reviewing a 1.6 billion pounds takeover bid that could turn the fledgling lender he founded almost 25 years ago into one of Britain's biggest banks.

Britain's mid-sized 'challenger' banks' shares rose sharply on Tuesday, after the approach by CYBG (CYBGC.L) for rival Virgin Money (VM.L), prompting speculation that long-awaited consolidation in the sector could become a reality.

Shares in Virgin Money, of which airlines-to-music mogul Branson owns about 35 percent, rose as much as 9 percent after the all-share takeover offer.

Rivals, including Metro Bank (MTRO.L) and OnesavingsBank (OSBO.L), also rose as investors bet on which of the challenger banks might be next to merge in a buoyant British M&A market, which has had record levels of activity.

These smaller banks emerged to fill a gap in small business lending left by the bigger banks, which retreated after the financial crisis to rebuild their battered balance sheets.

The challenger banks have succeeded in peeling some business away from heavyweights such as Lloyds (LLOY.L) and Royal Bank of Scotland (RBS.L), but in turn face their own threat from nimbler digital-only rivals and rising costs from tighter regulation.

CYBG, owner of Clydesdale and Yorkshire Bank, made its London market debut in 2016 after it was spun off by National Australia Bank (NAB.AX). A successful merger would create Britain's sixth largest bank, according to analysts.

Under its takeover plan, Virgin Money would own about 36.5 percent of the combined company. Virgin Money shareholders would receive 1.13 new CYBG shares for each Virgin Money share.

Virgin said on Monday its board was reviewing the CYBG offer.

"The current indicative terms in no way reflect the relative strengths of the two companies so CYBG would have to improve them significantly for us to even consider an offer," a top ten Virgin Money investor, who declined to be identified, told Reuters.

"There is some strategic logic and plenty of potential synergies in a combination of the two, but also plenty of execution risk, particularly from an IT perspective in light of recent events at TSB," the shareholder added.

TSB, which was bought by Spain's Banco Sabadell (SABE.MC) in 2015, has been hit in the past few weeks by a botched computer system migration as it moved to Sabadell's in-house system.

Analysts said the proposed deal, made public on Monday, made logical sense, combining CYBG's more extensive branch network with Virgin's stronger brand, but that the initial offer was too low and would likely be rejected.

"We think Virgin shareholders will be lukewarm on the proposal," said analyst John Cronin at Irish broker Goodbody, adding that he expected a protracted takeover battle could now happen as the two parties jockey over price.

SQUEEZED MIDDLE

Britain's mid-sized banks are being squeezed by competitive pressures from both the big established players and smaller newcomers, so analysts and investors have been expecting consolidation to kick off at some stage.

The biggest banks can reap economies of scale from their branch networks and ability to invest heavily in new technology. Meanwhile, a new breed of smaller digital-only 'neo-banks' such as Monzo, Starling and Atom and are wooing the customers of the mid-sized players without needing a costly branch infrastructure.

The challenger banks have also complained of an uneven playing field in terms of regulations, with rules on how much capital they have to hold against mortgages disproportionately favouring bigger players that have more historical data to underpin their risk models.

The CYBG and Virgin deal offers a potential template for coping with these pressures for many of the mid-sized players, providing an opportunity to combine branch networks, deposit bases and technology investment budgets.

Virgin Money is investing heavily in a new digital offering while CYBG already has a digital and mobile banking platform called 'B'.

(Reporting By Lawrence White and Sinead Cruise. Additional reporting by Ben Martin. Editing by Jane Merriman)