LLOY

BARC

There’s little cheer for banks as write-downs continue and monoline insurers add to the woe. Russ Mould surveys the sector to see how the banks stand

Shares in Bradford & Bingley (BB.) crashed 23% to a new all-time low last week, even though the Yorkshire firm unveiled a 5% rise in underlying profits. This may look an extreme over-reaction, but two key issues were at work.

Firstly, the lender took a further £225.6 million of write-downs, including a £94.4 million hit to its investments in structured investment vehicles (SIVs) and collateralised debt obligations (CDOs). Stated profits nearly halved as a result. Worse, the bank also admitted to £250 million in exposure to synthetic CDOs which were not mentioned at the time of November’s trading update.

Such revelations stoked equity market fears of what credit losses have still yet to be disclosed. Insurance giant AIG (AIG:NYSE) has admitted to an extra $4 billion of losses from insuring mortgage-related instruments, while just one week after its full- year results Credit Suisse has unveiled an extra $2.85 billion of credit trading losses. Its rival Swiss megabank UBS (UBS:Z) revealed it still has $38 billion in mortgage- and subprime-related debt securities, even after the $18.4 billion of write-downs it has already taken.

Secondly, Bradford & Bingley revealed an increase in arrears to 1.63% of its loan book, against 1.3% at the end of 2006. This translated into a 42% increase in the number of cases three months or more in arrears and in possession. Coming so soon after credit card firms American Express (AXP:NYSE) and Capital One (COF:NYSE) acknowledged rising delinquencies (Shares, 24 Jan 08), this paints a gloomy picture of the debt-swamped consumer’s ability to keep taking on more debt, and therefore to keep spending.

Central banks around the world are slashing interest rates, but if the consumer cannot borrow any more, no amount of cuts will help. A period of balance sheet repair will be healthy for consumers and banks alike, but the contraction in debt issuance and use could result in a slowdown in global economic growth.

Balance sheet repair is also vital at the so-called ‘monoline’ insurers, whose woes are the latest leg of the ongoing credit crunch. Bond insurer FGIC has lost its vital AAA debt rating status, while Ambac (ABK:NYSE) and MBIA (MBI:NYSE) are fighting to keep theirs, because of losses which could result from their exposure to subprime and mortgage-backed securities.

Entrepreneur Warren Buffett has offered to take on $800 billion of municipal bond guarantees from them. This could stave off one disaster. If the bond insurers did lose their AAA rating, billions of dollars’ worth of solvent and transparent municipal bonds – issued by schools and hospitals, yet insured under the monolines’ rating – would be sold by banks who can only hold AAA debt. This would drive up the cost of the public bodies’ debts, or even jeopardise their ability to raise funds and invest in their assets and staff, through no fault of their own.

But Buffett has not become a multi-billionaire for nothing and this looks like an attempt to cherry-pick the best assets and leave the bond insurers with the more toxic ones. Problems with SIVs, CDOs and the alphabet soup of disastrous debt holdings would not be solved, leaving banks facing more losses and forcing them to tighten up on future lending plans to bolster their own balance sheets.

Investors with a keen appetite for risk may be tempted by the UK banks, where PE ratios for 2008 and now generally lower than the yields on offer. But the latest batch of loss revelations still suggest it is too early to play the banks, though for those seeking to deploy such a high-risk strategy, Lloyds TSB (LLOY) and Barclays (BARC) seem the relatively safest ways in.

Shares says:

BUY Barclays, Lloyds TSB

HOLD HSBS (HSBA) Royal Bank of Scotland (RBS), Standard Chartered (STAN)