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Banks haven’t exactly been covering themselves in glory recently.
The sector has gone from one pratfall to another ever since Northern Rock first warned it was in trouble last summer. U-turns on rights issues, never-ending writedowns – there’s been plenty of badly handled mishaps to choose from.
But even by the low standards of the banking sector, Bradford & Bingley (LON:BB) has been particularly hapless. In fact, its latest bombshell managed to wipe £2.8bn off the value of the UK’s six biggest banks, even though B&B itself only started the day with a market cap of barely half a million.
So how did such a small bank cause such a big reaction?
The reasons behind Bradford & Bingley’s shocking share price slump
Bradford & Bingley has had a dreadful few months. In the middle of April, rumours arose that the bank was on the verge of launching a rights issue. At the time, B&B denied it strongly. However, within a few days, Royal Bank of Scotland had announced its plans for a rights issue, which was closely followed by HBoS.
With the floodgates open, B&B apparently changed its mind in mid-May, saying it would be raising £300m from shareholders, with new shares placed at 82p a pop, way below the share price at the time.
At the time there was no suggestion of a profit warning, but with the housing market deteriorating, and management under a cloud because of the U-turn, investors were clearly worried. B&B’s share price slumped as investors fretted over the state of the bank’s finances, until on Friday, B&B was trading at just 88.5p a share.
Then, on Sunday, chief executive Steve Crawshaw, whose position was probably already untenable, resigned due to health problems. Then yesterday, the bank finally issued the much-expected profits warning.
And what a warning it was. The group plunged into an £8m loss in the four months to April, compared to a £108m profit for the same period in 2007. Profit margins have dived as funding costs grew, while bad debts have rocketed – more on that in a moment. The group also wrote down a further £89m in sub-prime related assets.
The good news – what little there was – was that US private equity group TPG has picked up a 23% stake in the bank for £179m. But even so, the rights issue had to be entirely revised. Under the original deal, if the share price had fallen below 82p, there would have been no incentive for anyone to buy into the stock and the underwriters (UBS and Citi, the investment banks who undersigned the deal) would likely have been left on the hook for the whole £300m.
Obviously, this wasn’t something either UBS or Citi would have appreciated. Reports in the papers suggest that they might even have found reason to pull out if necessary. So the deal has been changed. Shareholders will now be offered 19 shares for every 25 owned, at the price of 55p a share. Rather than raising £300m, B&B aims to raise £258m.
But why did the other bank shares fall?
The chaos and the grim news on profits sent B&B’s shares diving 24% to 67p, and it’s certainly a messy situation. But why did other banks take such fright? For example, HBoS sank 10%, while Alliance & Leicester fell 5.2%.
Well, the main worries for other banks were in B&B’s trading update. The group – which is Britain’s biggest buy-to-let mortgage lender – saw bad debts on its buy-to-let mortgages jump by a staggering 50% between the start of the year and the end of April. More than 3,000 of B&B’s buy-to-let customers are now at least three months behind in their mortgage payments, from less than 2,000 at the start of 2008. Buy-to-let accounts for nearly 60% of the bank’s mortgage book.
Things will only get worse, said the bank. “The tougher economic environment will continue to push arrears beyond the current level.” As Sandy Chen at Panmure Gordon put it: “This is not the bottom. The UK housing market – not just buy-to-let – is turning south.”
And although the bank has been raising its mortgage costs, it’s not seeing the benefit feed through to its profits, because it can’t write enough of the new mortgages. As Derek Chambers of Standard & Poor’s tells The Telegraph: “I think the hope had been at Bradford & Bingley, probably at HBoS as well, that as they re-priced new mortgages they’d be able to pass on these costs.” But in fact, they are “stuck with more mortgages at low rates which are probably low margin or even negative margin, and they’re not able to free up capital to lend at the new higher rates.”
The trouble is, this is just the beginning of the housing market upheaval. The Bank of England reported yesterday that in April mortgage approvals hit their lowest level since the Bank started recording the data in 1993. Capital Economics reckons the data suggest we could be looking at “house price falls that are well into double digits by the end of the year”.
So all of the banks can expect their bad debts to rise from here on in, for quite some time. Any shareholders in B&B, RBS, or HBoS pondering whether to buy into their rights issues needs to forget their current shareholding and ask themselves: “Given the choice of all the stocks in the stock market, would I put my money in a bank right now?”
And for anyone with anything less than the strongest risk appetite, then in the current economic climate, the answer has to be no.
Turning to the wider markets…
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The upheaval in the banking sector took its toll on the FTSE 100, which fell 45 points to 6,007, while housebuilder Persimmon was also lower.
European markets were weaker. The German Xetra Dax closed down 88 points at 7,008 and the French CAC 40 fell 79 points to 4,935.
US stocks fell further as Standard & Poor’s downgraded debt in Lehman Brothers, Merrill Lynch and Morgan Stanley, due to the risk of “further write-offs”. The Dow Jones Industrial Average fell 134 points to 12,503. The wider S&P 500 fell 14 points to 1,385, while the tech-heavy Nasdaq Composite fell 46 points to 2,475.
In Asia, the Nikkei 225 broke a three-day winning streak, falling 1.1% to close at 14,279, while in Hong Kong, the Hang Seng fell 1.5% to 24,459.
Commodity prices were generally firmer. Brent spot was trading this morning at $127.61, with crude in New York trading at 127.56. Spot gold was at $894 an ounce. Silver was trading at $16.85 and Platinum was at $2,041.
Turning to forex, sterling was trading at 1.9644 against the dollar, and at 1.2602 against the euro. The dollar was last trading at 0.6416 against the euro and 104.19 against the Japanese yen.
And this morning, more evidence of tough times for airlines. Budget airline Ryanair has reported its first quarterly loss since 2004, and warned it may only just break even this year. The group is “largely unhedged on fuel this year,” reports Bloomberg.
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