The group reported a 0.5 per cent fall in mortgage lending to £57.8 billion in its first quarter to December 31.
It blamed the end of the stamp duty land tax relief, which came to a close after tapering to the end of September, as well as ongoing competition in the mortgage sector.
Virgin Money - formerly known as CYBG, the owner of the historic Clydesdale and Yorkshire bank names - also said business lending dropped 2.2 per cent to £8.3bn in the quarter as demand remained “subdued” and as the government's Covid-19 support schemes began to wind down.
But the group upped the full-year outlook for its net interest margin - a key measure of profitability for retail banks - and cheered a more buoyant outlook for the wider UK economy.
It said: “Despite the uncertainty posed by new variants and concerns over inflation, the strengthening backdrop and easing of government restrictions give some scope for greater optimism about the pace of the recovery.”
Virgin Money’s mortgage lending decline comes after UK banks have enjoyed booming home loan business during the Covid crisis, with tax breaks, rock bottom interest rates and changing buyer demand amid the pandemic spurring the market on.
But interest rates are now rising as the Bank of England looks to rein in surging inflation, having already been increased to 0.25 per cent last month and the first of more expected later this week.
This will help boost retail bank profit margins, but may further dampen mortgage demand.
Virgin Money said its net interest margins should be bolstered by “higher-yielding lending offset by mortgage competition and normalisation of the savings market”.
Chief executive David Duffy cheered a “strong” first quarter despite the drop in mortgages.
He added: “Our balance sheet is performing well, asset quality remains robust and we have increased guidance on net interest margin for 2022.
“We are optimistic about the pace of recovery of the UK economy based on growing consumer and business confidence, underpinned by lower unemployment.”
The group’s first quarter also saw it book lower charges for bad debts. It said 28 branches were closed in the quarter, as part of plans announced last September to axe 31 sites with the loss of around 112 jobs, taking its network down to 134 as at the end of January.
Mark Crouch, an analyst at investment network eToro, said: “After years of rock-bottom interest rates eating away at margins, the outlook for banks is looking a little rosier.
“Virgin Money has hiked the outlook for its net interest margin following the Bank of England’s decision to raise rates in December.
“With another rise expected on Thursday this week and several more on the horizon in the next 18 months, we should see improved profits in the banking sector, which has had to do with wafer-thin margins since the financial crisis.”