Branson’s Virgin Money Seen Disrupting U.K. Retail Banks

On a cold, clear January morning, Sir Richard Branson finds himself standing in the middle of a pedestrian-friendly street in Newcastle -- a hardscrabble city in northeast England -- becoming something he never thought he would be: a banker.

Bankers, after all, were the very embodiment of the Establishment at which Branson has spent his career thumbing his nose, Bloomberg Markets reports in its May issue.

Yet here he is in front of a bank decked out in the trademark red and white of his Virgin Group Ltd. and adorned with a banner proclaiming “Our Quest to Make Banking Better Starts Here.”

And here’s Branson doing what he does best, playing the entrepreneur as celebrity icon, man as marketing Ubermensch.

As curious bystanders and ogling fans gather, he smiles for the television crews, camera lights illuminating the 61-year- old’s preternaturally white teeth and uncannily yellow mane.

In September 2007, television reporters flocked to this bank branch to record a very different scene: a classic bank run that had customers lined up for blocks to withdraw their money.

The branch was then part of Northern Rock Plc, the British bank whose reliance on short-term financing resulted in its becoming the first casualty of the global liquidity crunch.

After extending Northern Rock 27 billion pounds ($52.6 billion) in emergency loans, the government nationalized the bank in February 2008.

The Big Five

It later split the company in two. Northern Rock Plc, a so- called good bank, inherited the retail operations -- some 1 million customers, 10.3 billion pounds in mortgage loans and 19.4 billion pounds in deposits.

It was still unprofitable, however -- losing 224 million pounds in 2010. Northern Rock Asset Management Plc, the so- called bad bank, was saddled with 50 billion pounds of its predecessor’s debt.

In November, the government sold the good bank to Virgin Money Holdings U.K. Ltd., Branson’s financial services company, for 747 million pounds in cash and 150 million pounds in convertible debt.

The price Branson paid is about 400 million pounds less than what the British government spent in January 2010 to bail out the bank -- leading opposition politicians to complain that the deal shortchanged taxpayers.

It may be easier to break into Buckingham Palace than to become a major force in British retail banking.

For two decades, the industry has been dominated by the Big Five: Barclays Plc (BARC), HSBC Holdings Plc (HSBA), Lloyds Banking Group Plc (LLOY), Royal Bank of Scotland Group Plc (RBS) and Santander U.K. Plc, which was Abbey National Plc until Madrid-based Banco Santander SA (SAN) purchased it in 2004.

‘Formidable Player’

They control almost 80 percent of personal checking accounts, 71 percent of mortgage lending and about 60 percent of savings accounts, according to the U.K.’s Independent Commission on Banking.

Now, the question is whether Branson can reorder British banking in the way his Virgin brand has disrupted industries from music to airlines to mobile phones.

“We will be a very formidable player,” Branson says during an interview at the former Northern Rock headquarters in the Newcastle suburb of Gosforth.

Branson’s move into banking comes as the industry faces massive regulatory changes and consolidation in the U.K. and throughout Europe.

Banks are being forced to quarantine their retail operations from their riskier investment-banking units and proprietary trading desks.

Turnaround Artist

“There is more structural change going on in the U.K. market than at any time in recent history,” says Ian Walsh, a partner in Boston Consulting Group’s financial institutions practice in London.

In his mission to revolutionize retail banking in Britain, Branson has teamed up with a veteran turnaround artist: U.S. private-equity investor Wilbur Ross.

Ross’s firm, WL Ross & Co., has invested almost 350 million pounds in Virgin Money for 45 percent of the company -- a stake roughly equal to Virgin Group’s own share in the business. “We think the potential for capturing market share from other banks is considerable,” says Ross, 74, who’s worth at least $2 billion, according to Bloomberg Billionaires.

Branson has started dozens of businesses with bold promises. Sometimes, as with Virgin Atlantic Airways Ltd., it has worked; other times, it hasn’t.

Shares of Virgin Express Holdings Plc, a short-haul European airline, lost most of their value before SN Airholding NV bought the company in 2004. And does anyone remember Virgin Cola?

Sex Pistols

With Virgin Money, Branson aims to bring change to an industry that has never been on the cutting edge.

“The two core elements of banking -- checks and branches -- have been around for more than a millennium,” says Brett King, a co-founder of Movenbank, a brand-new U.S.-based startup focused on mobile banking.

Virgin Money itself is more refurbishment than new build. In late 1994, Rowan Gormley, a venture capitalist Branson hired to brainstorm new business ideas, suggested Virgin get into financial services.

Everyone just laughed, Gormley says. Everyone except Branson. He loved the idea “that the guy who brought you the Sex Pistols could sort out your pension, too,” Branson wrote in his 1998 autobiography, Losing My Virginity (Virgin Books).

Ten weeks later, Branson created Virgin Direct, which sold low-cost index funds by mail and telephone. It later moved online and expanded into insurance and credit cards.

Virgin Money

In 2002, it changed its name to Virgin Money. By 2010, the company had 3 million customers and 2.6 billion pounds under management in its investment business.

And that year, when it first became licensed as a bank, it made a profit of 27 million pounds on revenue of 91 million pounds, according to financial filings.

Still, it didn’t have branches, and it lacked classic banking products such as checking accounts.

Virgin Money remained a small star in the firmament of Branson’s business universe, which includes at least 55 Virgin- branded companies with global revenues of 13 billion pounds in 2011, according to Virgin Group. Branson’s net worth is at least $4 billion, according to Bloomberg Billionaires.

Catapulting Branson’s bank onto the center stage of U.K. banking has been Jayne-Anne Gadhia’s goal since she became the company’s chief executive officer in March 2007.

The job represents a homecoming for the 50-year-old, 6- foot-1-inch (1.85-meter) former accountant: She helped Gormley create Virgin Direct and spent the next six years there.

Subprime Mortgages

At Virgin Direct, Gadhia pioneered a mortgage called Virgin One in partnership with Royal Bank of Scotland.

It lowered borrowers’ payments by offsetting their debt against savings. The Virgin One business had 3.75 billion pounds in loans by 2001, when RBS bought it outright for 100 million pounds.

Gadhia joined RBS, rising through the ranks until she oversaw the bank’s entire 70 billion-pound retail mortgage portfolio.

It should have been a potential springboard into RBS’s C- suite. Instead, Gadhia says, she came under pressure from her bosses to securitize subprime mortgages.

She balked and, in September 2006, called Branson. Within a week, she had an agreement to return to Virgin Money, this time as CEO.

Gadhia’s defection was well-timed.

In 2008, RBS suffered the largest-ever pre-tax loss in British corporate history: 40.7 billion pounds. Since then, the government has spent 45.5 billion pounds to bail it out.

Northern Rock

At Virgin Money, Gadhia turned her attention to another failing lender: Northern Rock. She sensed opportunity.

Buying Northern Rock would instantly give Virgin the geographical footprint and product range to vie with Britain’s biggest retail banks.

In October 2007, advised by investment bank Greenhill & Co., Gadhia put together a consortium to bid for the stricken bank. Among those Greenhill approached was Ross.

“Wilbur is a natural person to go to given his expertise in financial services and his experience investing in distressed situations,” Greenhill Managing Director Edward Wakefield says.

Ross made a name for himself as a bankruptcy specialist in the 1980s and 1990s at Rothschild Inc.

Among his famous workouts was Bank of New England Corp., whose 1991 bankruptcy was, at the time, the second-largest bank liquidation in U.S. history.

‘A Lot of Credibility’

Ross and Gadhia’s bid failed when the government decided to nationalize Northern Rock.

Although disappointed, the two stayed in touch. Ross says he was impressed that Gadhia continued to hit her profit targets throughout 2008 and 2009 despite a terrible economic environment.

“That built up a lot of credibility in our minds about Virgin management,” Ross says.

In 2010, he invested 96.5 million pounds in Virgin Money, acquiring a 21 percent stake. He also promised up to 500 million pounds more to support an acquisition.

Since 2008, Ross has pursued a contrarian strategy of investing in flattened lenders.

He has spent $1.8 billion on bank acquisitions, mostly buying regional U.S. lenders, although he also put $400 million into a $1.6 billion effort to recapitalize Bank of Ireland Plc in July 2011. Through March 23, the bank’s shares rose more than 27 percent on the Irish Stock Exchange.

‘A Bad Deal’

When the British government put Northern Rock back on the market last summer, Gadhia and Ross pounced. In the end, Ross contributed 250 million pounds to the purchase, giving him control of almost half of Virgin Money.

The Labour Party, which had been in power when Northern Rock was nationalized, immediately attacked the sale. Officials had spent 1.4 billion pounds to recapitalize the bank in January 2010. Now, the current government, headed by the Conservative Party in coalition with the Liberal Democrats, was getting back at most 910 million pounds in cash -- and that will only be realized if Virgin Money goes public or is sold within five years.

“This is a bad deal for the taxpayer,” says Chris Leslie, Labour’s shadow Treasury spokesman.

Leslie says he’s particularly concerned that the Treasury allowed Virgin Money to use 250 million pounds of Northern Rock’s own capital to fund its purchase.

“They gave the bank away with an envelope full of cash,” Leslie says of the Treasury.

‘Best Possible Deal’

Replying to a complaint from Leslie, Chancellor of the Exchequer George Osborne wrote in November that the government had secured “the best possible deal” for Northern Rock.

“There isn’t a government in the world that has nationalized a failed bank and not made a loss on reselling it,” Ross says.

In late February, U.K. Financial Investments Ltd., the government entity managing the Northern Rock sale, said it had first considered all other options -- including winding down the business, an initial public offering or a mutualization -- and that Virgin Money offered the best value.

Ross says Virgin Money is paying more for Northern Rock -- about 80 percent of book value -- than the current price-to-book ratio of most publicly listed banks, a point UKFI also makes in its report. In March, European banks had a median price-to-book ratio of 0.69, according to Bloomberg data.

After combining with Northern Rock, Virgin Money had 75 branches, 4 million customers, close to 17 billion pounds in deposits, a mortgage book of 14 billion pounds and a credit card business with 3.5 billion pounds of outstanding charges.

‘Biggest Challenge’

British banks, however, are struggling with historically low interest rates and an economy nearly at a standstill, with quarter-over-quarter gross domestic product falling 0.3 percent in the last three months of 2011.

As of March 23, net interest margins at the Big Five averaged just 1.6 percent, Bloomberg data show.

Citing these conditions, Standard & Poor’s downgraded Northern Rock’s long-term credit rating on Jan. 6, following the Virgin Money purchase, dropping it one level to BBB+.

In its report, S&P assessed Virgin Money’s business position as “weak” given its low market share.

British consumers present a paradox.

According to Which?, a U.K. consumer-advocacy publisher, on average just half of customers are satisfied with their savings account bank, 60 percent with their current account bank and 66 percent with their credit card provider.

And yet customers rarely switch banks.

“That is the single biggest challenge facing Virgin Money,” says Daoud Fakhri, a retail-banking analyst at Datamonitor.

Internal Motto

To stand out, Gadhia says, her bank will emphasize simplicity and transparency.

In January, Virgin unveiled its first savings account, offering 2.85 percent annual equivalent interest. It’s not the best available rate, according to financial comparison company Moneyfacts Group Plc.

The twist, according to Virgin Money, is that there’s no twist: no minimum balance requirement and no withdrawal limits. The interest rate is also the same whether a customer banks online, by phone or through a branch.

That’s an example of what Gadhia likes to call EBO -- short for everyone better off. It’s the bank’s internal motto. Whatever Virgin Money does should be good for customers and society -- and make money.

In at least one instance, however, EBO has imperiled Virgin Money’s goodwill with consumers.

Opaque and Unfair

Most U.K. banks offer nominally free banking and then recoup costs through overdraft fees or by bundling accounts with premium products such as deposit insurance.

Gadhia says this practice is opaque and unfair.

In early January, she told reporters that when Virgin Money starts offering checking accounts, it plans to charge everyone a small monthly service fee.

Consumer advocates and personal finance columnists portrayed Gadhia’s proposal as a money grab. Branson quickly distanced himself from the idea.

“The brave thing to do would be to just charge a fee,” he says in Gosforth. “But I think it can become misunderstood.”

Gadhia now says only that whatever the bank offers will be transparent.

Virgin Money suffered a similar backlash in March after it suddenly hiked interest rates for about 1 percent of its credit card customers.

Dedicated to Bransonalia

Just off St. Andrew’s Square in Edinburgh is a cross between a private club and a bank that represents another arrow in Virgin’s marketing quiver.

Inside this Virgin Money Lounge, customers sit on sofas and easy chairs sipping complimentary cappuccinos and surfing the Web using free Wi-Fi.

An entire wall is dedicated to Bransonalia: a gold-plated Virgin Records chart topper, photographs from Branson’s various yachting and ballooning adventures, a model Virgin train and so on.

Young women in eye-catching crimson skirts hand out iPads customers can use to learn about the bank’s products. Virgin plans to have five lounges, including one in London, open by the end of the year.

Umpqua Bank (UMPQ), based in Roseburg, Oregon, pioneered this concept. Umpqua’s 194 branches offer events -- from Wii video- game tournaments to live music -- more typical of bars or coffee shops.

“It is about creating an experience where people really want to come in to the bank,” says Ray Davis, CEO of Umpqua Holdings Corp., the bank’s parent company.

‘Guy With a Beard’

Since 1996, when Umpqua’s first loungelike branch opened, deposits per branch have more than doubled and its model has been imitated by, among others, ING Direct USA.

Howard Wheeldon, a senior strategist at London brokerage BGC Partners LP, is skeptical.

“It is in-depth service that matters,” he says. “Can that bank offer something that the others can’t? And I don’t mean a nice woolly seat to sit on.”

Virgin Money has one advantage that other banks can’t match: Branson.

“You have a young guy with a beard who didn’t wear suits and worked in the rock music business, and he developed an airline and people turned out to be willing to risk their lives and their children’s lives in a metal tube at 30,000 feet with this guy,” says Patrick Barwise, an emeritus professor of management and marketing at London Business School.

The Trust Barrier

Having crossed that trust barrier, Branson shouldn’t have too much trouble convincing people to let Virgin look after their savings.

And having bought Northern Rock well below book value, it shouldn’t be too difficult for Ross and Branson to make money.

Everyone better off? Maybe. Two billionaires better off? The odds look good.

To contact the reporter on this story: Jeremy Kahn in London at jkahn21@bloomberg.net.

To contact the editor responsible for this story: Laura Colby at lcolby@bloomberg.net.

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