UPDATE 2-Virgin Money hit by one-off costs despite return to profit

* Virgin Money posts half-year profit vs year-ago loss

* Shares drop 5% due to higher-than-expected costs

* CEO cautiously optimistic about improving outlook
(Adds share move, analyst comment, details)

By Muvija M

May 5 (Reuters) - Virgin Money spooked investors
with surprise one-off costs on Wednesday, knocking its shares
despite a return to half-year profit and a forecast for improved
margins.

Shares in Britain's sixth-largest bank fell 5% to 1.86
pounds at 0740 GMT after it reported exceptional costs of 173
million pounds ($240 million) including some related to its 2018
merger with CYBG and for a historic mis-selling scandal.

"In overall terms, we see the negatives outweigh the
positives," Goodbody analyst John Cronin said in a note.

Among the positive developments reported on Wednesday,
Virgin Money set aside 38 million pounds to cover
pandemic-driven bad loans, compared to 232 million pounds a year
earlier.

That helped Virgin Money report a 72 million pound pre-tax
profit, compared to a 7 million pound loss a year before.

"We are cautiously optimistic about the improving outlook as
the impact of the vaccination programme in the UK delivers
positive revisions to economic expectations," Virgin Money Chief
Executive David Duffy said.

The bank stopped short of following bigger British rivals,
including Lloyds and HSBC, who have released
provisions due to a better-than-expected outlook.

Smaller rival OSB also acknowledged the ongoing
uncertainty in a trading statement, while Metro Bank
last week gave no update on provisions.

Virgin Money's net interest margin (NIM) - a key measure of
profitability - dipped to 1.56% from 1.62%, as record low
interest rates set by the Bank of England hurt so-called
challenger banks, newer entrants who rely on lending the most.

Larger banks offer other financial services, such as wealth
management or investment banking, which have cushioned the hit
to margins from low interest rates.

Virgin Money, however, forecast that its NIM would be around
1.6% for the full year.
($1 = 0.7197 pounds)
(Reporting by Muvija M in Bengaluru and Iain Withers in London;
Editing by Alexander Smith)