Duncan Mavin is a former Bloomberg Gadfly columnist.

Virgin Money -- one of the challengers trying to take on the U.K.'s four big lenders -- is doing nicely, thank you. Profit is up; margins are strong and stable; and there's room to expand market share in deposits and mortgages.

CEO Jayne-Anne Gadhia says she will consider potential acquisitions that are "a good fit" and add value. But why take the risk?

Strong Challenge
The U.K.'s smaller banks have outperformed larger rivals in recent months
Source: Bloomberg

The bank's backers, who include Richard Branson and Wilbur Ross, have reason to be happy. Virgin Money has gained 14 percent over the past year while the FTSE All-Share Banks Index has tumbled 25 percent. The stock trades at 1.25 times book value, while many of its peers still trade at a steep discount.

The shares jumped as much as 9 percent Wednesday after Virgin Money posted a fourfold increase in full-year pretax profit and surprised investors with a dividend of 4.5 pence per share for the year.

All its core businesses grew: deposits, credit card balances and mortgages were all up. Mortgage balances increased 16 percent in 2015, outpacing the broader market's 1.8 percent growth, the bank said.

That didn't come at the cost of asset quality or price cuts. The net interest margin widened to 1.65 percent last year from 1.4 percent in 2014. Loans more than three months in arrears stood at just 0.22 percent of the total, compared with 1.12 percent for the industry as a whole, the bank said.

Certainly, there are big challenges ahead. Regulation is a risk -- in recent months, the U.K. government has clamped down on so-called buy-to-let mortgages and introduced a tax on bank profits.

The bigger problem, though, is the prospect that interest rates will stay at record lows for longer than previously anticipated. Many economists don't expect rates to pick up until at least 2017. That keeps up the pressure on net interest margins and potentially fuels more competition among lenders -- especially on pricing.

Against this backdrop, there is the temptation to do a big deal that would take Virgin to another level. Virgin has been touted as a bidder for Williams & Glyn, the specialist small business lender regulators are forcing Royal Bank of Scotland to sell. Nomura analysts say a deal would be "transformational," adding branches, 20 billion pounds ($28 billion) in loans fully funded by customer deposits, and about 12.5 percent to earnings per share by 2018.

RBS is, effectively, a forced seller, so a buyer can likely negotiate a good price. But a reduced price doesn't always indicate a bargain. RBS says it has 5,000 staff working on about 60,000 separate projects related to the task of splitting out W&G. It's hard to imagine that it would slip seamlessly into a buyer's business. Execution and integration would surely create a major distraction for management.

Room to Build
Virgin Money has just a 1.9% share of the U.K. mortgage market
Source: Nomura

Instead, there's more than enough scope for Virgin to grow its existing business. Virgin has only about a 2 percent share of U.K. mortgages, for instance. That market is dominated by the big lenders -- Lloyds, Nationwide, Santander, Barclays and RBS hold about two-thirds of it, according to data from Nomura. Market-leader Lloyds said it will "balance margin considerations with volume growth in the mortgage business," suggesting it won't be drawn into a nasty fight for customers.

Virgin Money has already set itself some ambitious targets, including mid-teen returns by the end of 2017. That's up from 10.9 percent in 2015 and 7.4 percent in 2014. On average, European banks are expected to deliver a return on tangible equity of 10.4 percent by 2017, according to Bloomberg Intelligence.

Meanwhile, Gadhia said on Wednesday the banks doesn't "need to do anything M&A-wise" and indicated a prudent approach to dealmaking.

Investors should hope she stays true to that promise.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Duncan Mavin in London at

To contact the editor responsible for this story:
Edward Evans at