Diary of the 2008 UK Banking Crisis

Below, a series of articles looking at the how the UK banks went through a crisis in 2008.

Also see our guide to trading the bank sector.

Banking Sector Takes Triple Whammy

Below, an article by Simon Denham, Financial Spreads, 18-Feb-08.

The banking sector, which has been pretty hard hit anyway, took a triple whammy this week:

• UBS reported almost unbelievable sub prime/credit losses
• Bradford and Bingley reminded us that there are other parts to banking portfolios that are at risk
• The Germans revealed their own efforts to avoid a financial meltdown in the smaller bank sector

Share prices and yields look almost ridiculously cheap at current levels with Stock such as Bradford & Bingley giving over 10% and both Barclays and RBS around 7%.

For companies that are likely to be around for a very long time, these look (when compared to even their own issued paper let alone UK Gilts) to be very tempting indeed.

Punters have been hovering up stock as well as hoping for some bounce back from the recent lows but the continued flow of bad news has seen set back after set back.

The problem for the big investors is not the value as expressed today but the value in a few years time.

With shell-shocked balance sheets, massive capital injections (at considerable cost) and virtually no chance of big takeover or merger stories (except in extremis) bank sector analysts are worrying about future growth potential.

Share prices reflect not so much the value of a company today but the probability of growth tomorrow. A company showing 20pc long term growth history will trade on a much better multiple than one showing 5 or 10pc.

So how do you value a sector that is in danger of giving negative numbers for the foreseeable future and may very well have further shocks from, as yet, unforeseen quarters?

As with so much these days this whole question will revolve around your expectations for the state of the global economy. If, like many, you believe in world wide economic weakness then, even at current prices, the banks may very well be poor value but if you are more optimistic and believe that the Non Western portion of the global environment will pull us out of the fire then a small dabble may well pay off in the long term.

In all investing actions there is calculation and risk. At some point the possible gains will outweigh the probable risks and it is the shifting sands of this equation on which the efforts of those hugely powerful ‘black boxes’, churning away in the dark corners of Morgan Stanley and Goldman Sachs, will be focused. One of the ways that we, as mere mortals, can attempt to catch any wave is to watch the trading volumes and await the time when a reasonable increase in these equates with a stable or rising market.

In the meantime the advice remains the same, sit back and keep your arsenal powder dry.

Adieu Northern Rock

Below, an article by Simon Denham, Financial Spreads, 18-Feb-08.

So…adieu Northern Rock hello www.nr.gov.uk.

The only real option open to Capt’n Darling became his final decision.

Offloading the whole kit and caboodle into the private sector with a big government guarantee was never going to fly.

The political fall out from huge wealth being created in the private sector from handing over an ‘operationally’ profitable bank for peanuts would have been an albatross around the neck of the Labour Party for years.

The bank can now be wound slowly down (or aggressively if the government wishes it) whilst making substantial sums for the exchequer at the same time and then sold off after attracting reasonable long term funding commitments from other banks.

With the Government now taking up 45% of the entire economy it is nice to know that a small part of it will actually be making a profit!

The only black spot is the possible legal ramifications from investors but this should be assuaged by paying the closing price on Friday to each and every share holder as it would then be difficult to argue that you had not been paid a fair market price (as that was the market price at the time).

This week is the beginning of the bank reporting season and both Barclays and Lloyds have indicated that they will be raising dividends.

This is not a ‘weak’ signal! The banks have other sources of income than ‘sub prime’ mortgages and, whilst growth may be difficult to come by for the next year or so, the other areas are doing very well indeed.

Barclays have indicated that, even after writing off all their dodgy debt (they may well get a lot of it back), they will match last years numbers.

World growth (not the UK or US) is still very robust and the big players earn a huge slice of total revenue away from these shores.

The reason for the extreme weakness of operators such as Bradford and Bingley is that they have too many of their eggs in one basket (aka Northern Rock) and are heavily reliant on UK growth.

Their forays abroad, a surprise anyway for many investors, seem to have brought nothing but pain which will naturally create a tortoise like retreat into the ‘safe haven'(!?) of home just as it looks to be contracting.

For those who think that shortage of land is a protection against price falls, the lessons of Japan (an even more ‘green belt’ protective nation than the UK) are educational.

It was the travails of the banks over there which precipitated the huge falls in real estate values (at one time property fell some 70% off the peaks) and we can only hope that the same does not happen here.

Varying indicators from the economy shot across our radars last week and whilst we can worry about inflation (next months number should be a doozy) long term pressure looks slightly less obvious.

Wage demands are not getting out of control, aside from ‘outside influences’ inflation is not accelerating and we might be about to pass the worst of the commodity based inflation anyway.

The real pressure on the UK economy comes from the public sector not from the private, which has been doing reasonably well of late. With so much of our economic interests now tied in with government expenditure the prospect of this being pared back do not bode well.

With a very poor trade deficit and public sector deficit there are many arguments in favour of a weak pound and if this happens (in conjunction with a sudden increase in government debt issuance) the consequences may be dire.

Lehman Next in Line?

Below, an article by Simon Denham, Financial Spreads, 18-Mar-08.

Well we could be in for a bit of relief today as the markets all seem to have stabilised to some extent since the dramas of Friday and Monday morning.

Rumours that Lehman might be the next in line for implosion after DB Singapore apparently refused their name in the money markets were quickly quashed.

The stock was at one point some 50pc down on the day at around $20.50 but later bounced as investment banks rallied round and closed ‘just’ 23% off at $30.50.

MF Global, the US arm of Man Group in the UK, which was sold off last summer for those of you who remember, fell by well over half on rumours of Hedge Fund withdrawals.

The company has had a truly grim start to life as the float was pretty much a disaster in the first place followed by a ‘rogue trader’ event a few weeks ago and now rumours of heavy withdrawals.

‘If’ they manage to survive the current rumour mill the stock could be the buy of the year.

eeerrr…Sorry, actually I think that JP Morgan have managed that with the $2/share acquisition of Bear Stearns (who were expected to announce strong numbers this week).

Seldom can an acquiring party have received such a one off boost to its value.

Not surprisingly, as virtually every other financial share on the planet was falling around 10%, JP Morgan Chase’s stock went up by 10%. I wish the Fed had knocked on my door.

“Dear Sir …will you take over a rival who is very profitable but is temporarily a bit short of funding. Oh! … by the way, we will also give you the funding that they require.” I bet Chase almost bit the Fed’s hand off.

There is an eerie lack of activity across the board this morning as dealers try to take stock of the suddenly changed world in which they are likely to be operating in for a while.

However the buyers are definitely out in the early light with the FTSE looking to rebound from yesterdays dramatic drop with a 100 point rally on the open this morning. First calls are at around 5515 for the FTSE 100.

Banking stock is likely to be the big mover on early indications with HBOS, Barclays and RBS likely to bounce from yesterday’s panic.

With much of the bigger banks’ revenue coming from foreign shores the fall in the pound may well make those earnings look rather tasty. And for all the slight slowdown in Far Eastern, growth it is still around 7 to 8pc.

Whilst we might look with trepidation at the current situation for the US, UK and bits of Europe it cannot be denied that the rest of the world is doing OK thank you very much.

As mentioned before the slow decline in major bank names has been going on for some considerable time.

The UK now has only a small handful of players, Europe and the US have seen a veritable tidal wave of mergers and acquisitions over the past decade and the current situation would seem to indicate that the stronger placed institutions may well come out of this in rather a nice position.

While the sentiment today is very rosy to start with the hunt for the next weak link goes on. Barclays’ failure to win ABN must now look like one of the best silver medal awards of 2007 as RBS, Fortis and Santander struggle to swallow the mouthful.

The bank even managed (in losing) to actually make a profit and to weaken its competitors in the process. Over in Switzerland the Gnomes are furiously trying to bolster UBS which seems to have come out as the most exposed of all the major Europeans to the current woes in the US.

As banking is virtually the only export product for the country it is unlikely that the Swiss authorities will stand back and let such a flagship company go to the wall.

Banks Took Yet Another Battering Yesterday

Below, an article by Simon Denham, Financial Spreads, 8-Jul-08.

Banks took yet another battering yesterday even though the FTSE 100 rallied some 96 points and the steady selling seems to now be almost masochistic (yields on Barclays are almost 12%) and the feeling spreads that ‘somebody must know something’.

Put option strategies written years ago are now triggering renewed selling as funds are forced to sell ever more stock to ‘delta neutral’ their positions. Perversely more traders are buying into protection for existing positions therefore, possibly in these thin days, creating the very effect they are trying to avoid.

The bottom line is that the big funds fear that holders will end up with massively diluted holdings as the investment and retail banks are forced into more and more rights issues at worse and worse levels.

Many cash calls were written at some 30-40% below the valuations pertaining at that time and what happened? The stock just sold off to the rights issue price. What happens if there is another call? Will the stocks halve again?

At some point this ‘elastic band effect’ will reach it nadir and prices will shoot off like a rocket but that day is probably not yet.

Looking back at the price action on Barclays since the start of the year we can see that even though the price has fallen some 42% we have actually had two 30% rallies, a 24%, a 22% and a 15% rally whilst this has all been going on as investors have continually tried to call a floor.

With the mortgage units on the slide in the UK, the treasury units virtually moribund due to the credit crunch and corporate lending not exactly rip roaring away it is tempting to assume that the worst has not yet been reached but at some point the big players will dip into the market (if only to pick up very cheap strategic positions).

Citigroup, the worlds biggest bank by revenue, is now worth less than the amount that RBS, Fortis and Santander paid for ABN last year.

No disrespect to ABN but they were never a major player and were forever playing catch up in the world investment bank league table so, with the benefit of a good dollop of hindsight, it becomes increasingly unclear as to what value the various banks ever saw in paying such a huge premium at the top of a four year bull market.

On top of all the problems that the banks are facing is a big factor marked ‘credibility’. Nobody believes a word they say any more (even if it is true) and analyst poke through all data with a view to unearthing creepy crawlies under a rock rather than finding diamonds in the muck.

Bradford and Bingley seem to have managed a new nadir in this respect with every pronouncement being seen to be ‘economical with the truth’ and every decision perceived as being self serving to the board in place and ‘sod the investors’.

Many esteemed economists are now expecting the current state of affairs to last for some years to come with economies verging on a state of recession for many quarters.

In this scenario it will probably be a while before the banking sector manages to get off its knees (look at what happened in Japan) so the temptation to dip a toe into the banking waters should probably be resisted for the time being.

Banking Sector Problems Continue

Below, an article by Simon Denham, Financial Spreads, 15-Jul-08.

And so the pieces all start falling into place.

The UK’s huge dependence on debt to finance everything from that holiday in ‘Majorka’, a new ‘motor’ every few years or little Johnny’s absurdly expensive School fees are now coming back to haunt us.

Home owners have become used to ‘unlocking’ the value in their houses to buy today what they probably could not even afford tomorrow.

The belief that the good times would go on forever has now cost us two banks with a third clinging on for grim life.

Santander’s audacious bid for Alliance and Leicester looks to be going through on the nod to the relief of all concerned (shareholders, Treasury, BOE and FSA) and little will be made of the fact that they are paying a valuation that was in the market just two weeks ago.

What a difference ten trading days can make!

For those who argue against short sellers being allowed yesterday’s action in A&L will come as something of a lesson. This is exactly the type of risk that ‘shorters’ take.

Some £150m was probably lost in just a few minutes by funds betting on continued weakness, as the A&L stock was one of the most heavily borrowed stocks on the block.

The price opened some 40% to the good from the close on Friday and nobody had a chance to get out. The stock rallied to well above the Santander offer even though the chances of a competitor bid appear slim (although not impossible) as shorts were forced to cover at any price.

The market relief did not last long for other banking shares as the initial boost to Barclays, RBS and Bradford and Bingley had pretty much drained away by the close.

And, after the Dow’s dismal performance last night followed by a 2-3% drop across the Far East, this morning we are likely to open lower again. After Eleven years of Labour ‘growth’ the investment value of UK plc is now well below its levels of 1997 (taking out all the foreign members of the FTSE 350). Even the slightly more overt Fed backing for Fannie Mae and Freddie Mac did not help out. The fact is that whilst the US Treasury might guarantee the debt (for fear of a total collapse of US debt markets) this will not aid the share holders. This is potentially a Northern Rock US style. The US Treasury may effectively take on the entire multi trillion dollar mortgage book to avoid an implosion and just wipe out the stock.

This will be yet another call on US public funds and, with the Middle Far East being virtually the only major buyer left for US T Bonds, there must be a fear that indigestion will eventually limit buyers continued appetite for US debt.

Other US financial stock is also looking a tad fragile with the banks due to report soon on first half ‘performance’.

HBOS Cash Call Underwriters in Trouble

Below, an article by Simon Denham, Financial Spreads, 17-Jul-08.

An exceptionally strange day with European markets pluming the depths in the morning only for the US to come in and completely alter the sentiment.

Markets are expected to open substantially to the good this morning with financials especially favoured (for once).

RBS hit 144p during the morning session with the board presumably thankful to have the rights issue out of the way already.

No such luck for the underwriter of the Barclays and HBOS cash call. At one point HBOS hit 225p, 50p below the 275p strike price which presumably means that HBOS will now have two investment banks as major shareholders as nobody in their right minds would take the rights when they can buy the stock much cheaper.

Barclays (low of 238p) closed at 266p still well below the Plimsoll line.

The problem here is that the underwriters are not natural holders of the stock. Morgan Stanley and Dresdner Klienwort have, presumably, no real interest in owning 40% of HBOS unless they wish to mount a takeover bid.

This means that the market knows that there is a big seller out there and it also knows that even a takeover bid would not need much of a premium as a huge minority stake is easily available.

They are believed to have offloaded a substantial portion of the underwriting but must have traded a good few favours to do so.

The same argument can be made for the Barclays issue with the book closing this morning the chances of anyone deciding today (even if the stock rallies strongly in early trade) to take up the rights is low. Our brokers effectively bought our rights in the open market yesterday well below the 682 mark and I would expect most major players to have done the same.

The relief rally in the States will be eyed with suspicion by the markets today as the fear of being caught up in a ‘dead cat bounce’ will weigh on traders minds.

Looking back at recent history even the precipitous fall over the past seven weeks has had the odd big plus day and the natural tendency will be to eye yesterdays price action as just such a trap.

Longer term investors will be picking over the most shell shocked of the stocks to try to find some potential diamonds in the mud as they know that there is little chance of picking a bottom but every chance of getting in at level which, in a few years time, will look very attractive.

Unless we believe in an Armageddon scenario many financial stocks would appear to be well oversold. Most of the big players are now saying that they need no more cash calls to bolster their balance sheets which, if it is true, would make yields and potential price growth very attractive indeed.

Unfortunately, as we can see from the slumping values, more people are currently worrying about continued dilution of equity in the shape of further rights issues than believe in any recovery.

5/7 UK Banks Lose 50% in One Year

Below, an article by Anthony Grech, IG Index, 16-Sep-2008.

Over the past year, UK banks have incurred a significant amount of writedowns on the back of devalued sub-prime related securities.

Earnings and balance sheets across the banking sector were dented and a softening economic outlook in the UK and US, coupled with fresh sub-prime news, caused selling pressure on banking shares to mount.

Of the FTSE 100 banks; HSBC, RBS, HBOS and Barclays were the worst casualties in terms of writedowns and credit losses between 2007 and 2008 according to Bloomberg.

During this period HSBC incurred £9.8 billion in writedowns and credit losses, followed by RBS with losses amounting to £7.8 billion. During the same period, HBOS and Barclays suffered from £3.6 billion and £3.2 billion in credit losses and writedowns, respectively.

These writedowns (which are extremely complicated to value) have contributed to elevated levels of liquidity and default risks and the primary cause for the sharp sell-off in the sector.

Although the sector has incurred a large amount of writedowns, there remains a view that further losses are in the pipeline: analysts recently stated that banks may have to continue slashing dividends and issue additional equity in order to counter further writedowns and liquidity constraints.

On 26 June 2008, this view was reinforced when Belgian bank Fortis announced that it would cancel its 2008 interim dividend, issue new shares and sell non-core assets in order to revive its balance sheet. Analysts at Goldman Sachs predicted further writedowns for Citigroup, the world’s largest bank.

Consequently, expectations of further and possibly larger writedowns are likely to lead analysts to revise their banking sector earnings lower and this outcome will add further downward pressure on share prices.

High oil prices and a softening economic outlook have also contributed to the negative sentiment surrounding FTSE 100 stocks. Companies are shedding labour as energy costs eat into corporate profits and banks are scaling back on staff in order to prepare for potential losses and protect liquidity levels.

According to Anthony Grech of IG Index “This has had implications on the wider economy. As UK companies shed labour, mortgage defaults rise and banks, which are already anticipating the worst, continue to tighten lending criteria. Data released in June confirms that UK bank lending, as measured by the BBA mortgage approvals, dropped at an annual pace of 56.1% in May.

This vicious circle is adding to fears and weakening the outlook for the British economy further. It is also enticing investors to safer, higher yielding cash and money market instruments and probably contributing to the selling pressures across the entire equity market”

However, are we close to the bottom? Should we be spread betting on equities like bank shares to go down or not? A recent analysis of the performance of seven FTSE 100-listed banks revealed that five out of the seven banks halved in value in just one year.

As of close on 23 June 2008, Alliance and Leicester was 74% below last year’s price followed by HBOS with a 73% annual decline. Moreover, RBS’s share price was 66% lower over the year while Barclays and Lloyds were down by 58% and 44% respectively. Is the sharp sell-off overdone or is it too premature to tell?