Fool's Eye View

[ October 16, 2000 ]

Egg's Third Quarter

By Rob Davies (TMFEssex)

Carburton Street, London -- Internet companies are in a league of their own when it comes to putting positive spin on news. This is how Egg (LSE: EGG), the Internet bank, commented on the £443m decline in its deposits to £6,815m in the third quarter. It said:

"Even the decline in total deposit balances is on the whole positive for Egg, as it reflects a transition to a more valuable customer base with a high propensity to transact over new channels, especially the Internet."

In my experience no company ever grew by getting smaller. It is true that the total number of customers has increased by 120,000 to 1.2m, but the implication must be that the savvier, early investors have responded to the reduction in deposit rates by moving their money elsewhere. The switch in the interest rate structure from a negative 5 basis points to a positive 55 basis points was the reason for the net migration of funds, but it did mean that interest income shot up to £54.6m for the nine months. However, that was surpassed by £37.3m increase in administration expenses, a £5.7m rise in depreciation and an increased provision for bad debts of £24.8.

As a result, the loss before tax only rose to £115m from £108m, and the company says it is on track to meet its business targets. The real growth in the future will come from cross-selling higher margin products to its existing customers.

This table shows some of the assets and the income generated from them:

Assets            Balance (£m)    Rate %

Mortgages            1,943        6.73
Personal Loans         288       10.36
Egg Card               526        6.06
Total average        8,390        6.45
Customer accounts    7,670        5.90

The evolution of the bank's interest rate structure is illustrated in this table.

Nine months to 30th September     2000      1999

Interest income (%)               6.45      5.68
Interest expense (%)              5.90      5.73
Interest spread  (%)              0.55     (0.05)

These figures seem to justify the bank's optimism that it is on course to make money. Although smaller, and riskier, the personal loan business is much more profitable. If Egg can persuade more of its customers to take out these higher margin products then the fall in its deposit base won't matter. But, as the Halifax (LSE: HFX) showed last week, competition for the retail customer is ferocious. In the past all lending booms have come to grief because banks lend to the same segment and fight for market share. The concern is, as always, that credit quality will suffer as the bank grows by going down market.

At least with the Halifax you can get a higher return on your money by buying shares in the bank than lending it money. Its dividend yield of 4.8% yield is higher than the 4% offered on overnight money. Even with these results, it will be some time before the dividend yield on Egg shares beats its deposit account rate.

Tell us what you think on the Egg and Banking sector discussion boards.