August 18, 2008 | posted by Michael Baxter in Banking | comments (1) |

Failure surely is the price we pay for our errors. If we don’t pay a price, then what incentive do we have not to repeat those errors?

Now former Fed chairman Alan Grenspan has entered the debate.

Mr Greenspan told a US newspaper that the Fed and the Treasury “should have wiped out the shareholders, nationalised the institutions with legislation that they are to be reconstituted as five or 10 individual privately-held units,” which would eventually be sold off.

It is a tad ironic. While at the Fed Mr Greenspan didn’t actually do the bail out, but he did orchestrate a rescue of Long Term Capital Management, so that the hedge fund that messed up so spectacularly never actually went bankrupt.

Maybe it was because US banks never actually suffered sufficiently for their recklessness in the mid 1990s, that they went on to repeat the same mistakes this decade.

But at least Northern Rock did actually fail in the end. The UK government did receive all kinds of flak for the Northern Rock debacle, but surely some kind of bail out, preserving the bank, would have sent an awful message to the other banks.

History tells us that the failure of banks can have a catastrophic effect upon the economy.

The economic depression in the US of the 1930s was partly the result of mass banking failure. More recently, Sweden, for example, suffered a major banking crisis in 1991 – and the cost to the economy – 6 per cent of GDP; further back in 1987 it was Norway that was struck, and the cost – 8 per cent of GDP. But in 1997, it was Spain which felt the horror of a full-scale banking crisis – and the cost, 16 per cent of GDP. Examples of other major banking crises include France (1994), Germany (1977), Japan (1992), the US (1984), but top of the order comes the UK (1974, 1991 and 1995). (data supplied by NIESR 2008.)

But things go in circles. Bank failure has in the past caused economic crisis. Maybe, this time around, not enough banking failure has caused this crisis.

August 8, 2008 | posted by Michael Baxter in Banking | comments (0) |

And so RBS reveals its first ever half yearly loss in the forty years since it became a public listed company. It was also the second largest loss ever revealed by a British bank. Only Lloyds has ever managed to out do it, but that was back in 1989, and over Latin American debt.

Of the big five, RBS is the first bank to reveal a credit crunch related loss. But the key question is this: Is the worst now over, can we look forward to improved bank results, or is this just the thin end of the wedge?

RBS lost £691m in total – that is bad, but then again, consider this in the light of a £5bn profit in the same period last year, and while the decline in its fortunes is worrying, it is not as if the bank doesn’t have years of cumulative profit to fall back on.

Also, consider the losses in the light of the £12bn or so the bank has raised through selling shares lately.

These days, the strength of a bank’s balance sheet is measured by something called a Tier 1 Capital Ratio. This takes cumulative pre tax profit minus dividends, adds this to all investment the bank has received though the sale of shares, and then states this total value as a proportion of risk-weighted assets.

RBS now has a tier 1 capital ratio of 5.8 – that is after taking into account the sale of the bank’s stake in Tesco Personal Finance. To put that in context, the Basel Committee on Banking Supervision says banks should have a tier 1 capital ratio of at least 4 per cent. Barclays recently said it has a tier 1 capital ratio of 6,3; HSBC 8.8; Lloyds 7.4; and HSBC 6.5 per cent.

To put it another way, despite the massive fund-raising, the RBS has a lower tier 1 captial ratio than any of its four main UK rivals.

And the reason is easy to see. RBS, Santander of Spain and Fortis of Belgium forked out $110bn to purchase ABN Amro last year.

Although Santander seems to have absorbed its share of the takeover in its stride, both Fortis and RBS have had to get shareholders to stump up money, even though both the banks at first said this would not be necessary.

Mind you, there was some good news from RBS. The loss was much lower than expected.

In part this was because the bank has had some luck selling leveraged loans at a higher price than it had expected. The bank saw an £182m reduction in the value of its debt.

What about the future? Sir Fred Goodwin, chief executive at the bank said: “It doesn’t feel like we’re heading back to the good old days, but we are seeing some movement,” and he added: “Its a brave person that can try and predict this market through year-end, but we feel these are strong marks and we have a reasonable degree of confidence. We’re still reducing exposure. We feel more comfortable with these marks now than at the end of April.”

The big snag, though, with all the write-downs announced by the banks so far, is that it seems unlikely that, moving forward, they have taken sufficient account of the effect the credit crunch will have on indebted UK consumers.

It may be that we have seen the majority of US subprime write-downs taken into account now, but the US and UK property markets have an important difference.

As is explained in the article below – “House prices fall again, but at least they rise in the US,” in the US, the banks often have to pay the cost of the negative equity in a mortgage. In the UK, most of us with negative equity have to just struggle on. Meaning, the effect of negative equity could take longer to be felt in the UK.

The underlying forces that shape the economy can affect different sectors at different times. At the moment, it is the banks who are feeling the full force of the credit crunch. Over the next year or two, it will be business and consumers.

The economist Hyman Minsky once talked about three stages in the development of a credit bubble. Stage 1, borrowing is affordable. Stage 2, borrowers can’t afford to repay the loan, but they can afford to pay interest. Stage 3, they can’t even afford the interest, and may borrow from elsewhere to repay existing loans. Then, all of a sudden, credit dries up – backlash against the untenable borrowing occurs – this is called the Minsky moment.

For many consumers it seems as if they are close to reaching that Minsky moment. This will be the point of maximum danger for the economy. It seems that as consumers find they are no longer able to borrow to repay borrowing, defaults will rise.

Businesses could face a double blow. As the economy slows they may need to borrow more, but for many, the credit crunch will make this impossible.

As a result, British banks could face rising defaults from both consumers and business – and for those reasons, it is quite possible bank losses have further to rise.

August 5, 2008 | posted by Michael Baxter in Banking | comments (0) |

As you know HSBC, revealed its latest results – as was told here yesterday. Profits were down, at $10.2bn hardly disastrous. The total amount set aside to cover bad debt was increased by another $10.1bn; that’s a lot of money, but HSBC can afford it. There is no talk of a rights issue, instead the bank upped dividends.

The real significance of the HSBC results comes in other guises.

For one thing, don’t forget HSBC was the first bank to warn of subprime dangers. Maybe then HSBC can give us a hint as to what will happen next.

And that brings us to the really interesting information to emerge from HSBC yesterday. The musings of its chairman.

Stephen Green, the big boss at the bank says a US recession is still a “real risk.” He added: “… the length and depth of that is uncertain. I think if a recession occurred it could be shallow … but any meaningful recovery in the housing market is unlikely before next year. Employment is fragile. These are difficult conditions and they will remain difficult into next year too.”

As for Asia – and remember HSBC knows more about Asia than just about every other European or American bank – he said: “I don’t think emerging markets have completely decoupled from Europe, North America or Japan. There has been an element of decoupling. There is an increasing amount of exports to other destinations.” So what will the effect be of a US recession then? “There will be an impact,” he said, “there is no question.”

We are a tad cynical about this decoupling idea. The US is a massively important customer for China. It is also an important customer for China’s customers. If the US hits recession, China will feel it hard.

One other piece of interesting information from HSBC: The bank said there was an average 5 per cent drop in current account bank balances among UK customers during the latest period.

So, HSBC’s customers have had less money to spend. Well, we all knew that was true – but it’s nice to get conformation. But here is where we really are cynical. How can inflation take hold, in the longer-term, if the amount of money in the system is falling?

August 5, 2008 | posted by Michael Baxter in Banking | comments (0) |

And so Northern Rock reveals a £585 million loss. It just goes to show that all those noises we heard about how the bank was profitable, and that people were panicking unnecessarily, were false. For a bank of Northern Rock’s size the loss is simply enormous.

Sure, the exodus of customers when it suffered the infamous bank run last September didn’t help. But the big reason given for its loss is debt write-downs for struggling mortgage holders. It now says 1.18 per cent of mortgage customers are struggling with payments – this is three times up on the amount seen before the credit crunch.

We were told Northern Rock didn’t do subprime lending and, therefore, its mortgage book was safe.

But, what it did do was 125 per cent mortgages.

Good, the bank has repaid £9.4bn. There’s just £17.5bn to go.

Not so good; the government is stumping up another £3bn, to boost the bank’s finances. That’s a £3bn investment.

A £3bn rights issue is simply massive. Not even the big US banks tried to raise that much money in one go.

On the Today programme Alistair Darling said Northern Rock was in a “very difficult” situation.

Ummm. For that matter so is Alistair Darling.

August 4, 2008 | posted by Michael Baxter in Banking | comments (0) |

If you wanted to try and encapsulate the two conflicting forces at work today in one company, then that company may well be HSBC.

Its strength is implied by its name: never forget HSBC stands for The Hong Kong and Shanghai Banking Corporation.

But the bank also has strong interests in the US.

And so it was that the bank posted a healthy profit of $10.2bn for the latest quarter, and while all around rivals are tapping shareholders and sovereign wealth funds for money, HSBC has actually upped its dividend payment for the first half of this year on the same period a year ago.

On the other hand, losses from the North American arm came in at $2.8bn and the total amount set aside to cover to bad debt was increased by another $10.1bn.

Profits for the same period last year were $3.9bn higher, so yes, HSBC has suffered a hit. Yes, profits are down. But, it really isn’t that bad,

Chairman Stephen Green said: “It is clear that growth models in our industry based on high and increasing leverage will no longer be sustainable.”

He added: “It is also clear that complexity in financial services and the recent consequences of failed risk management need to be addressed.

“Ultimately the real economy will recover from the crisis although it may get worse before it gets better. Financial markets will not, and should not, return to the status quo ante.”

August 1, 2008 | posted by Michael Baxter in Banking | comments (0) |

Well, it can come as no surprise to learn that profits at Alliance and Leicester have plummeted.

In all, profits before tax in the bank’s first half came in at just £2m. This compares with £290m in the same period last year. In other words, profits fell by 99 per cent.

Bet you can’t guess who got the blame for the fall? Give up already? Well, it was the credit crunch.

Presumably senior management and shareholders are saying Phew – thank goodness for the Spanish and its bank Santander, which is buying up the Alliance and Leicester.

Of course it barely needs saying, but it is worth recalling anyway, that all banks are going to be extremely shy about jumping back on the lending bandwagon for a very long time. Well, they have got to repair their balance sheets first anyway.

July 29, 2008 | posted by Michael Baxter in Banking | comments (0) |

And the little one said, “Roll over,” and there were six in the bed, and the little one said, “Get out of my bed! Who do you think you are, trying to jump onto my mattress?”

As one by one the banks either join the ranks of the public sector – Northern Rock; fight for their survival – Bradford and Bingley; get swallowed up by the Spanish – Alliance and Leicester; or find themselves the subject of rumours about being broken up – HBOS; along comes a new, brash bank, full of big ideas and, frankly, full of promise.

Tesco is planning to launch a bank.

At the moment its financial services arm is a joint venture with RBS. But, at a time when no one seems to have much money, it is planning to buy its partners out for £950m. One assumes RBS is pretty happy about that.

Tesco’s plan for its bank is bullish. It’s targeting a £1bn a year profit within ten years. To put that in perspective, in 2007, Lloyds TSB enjoyed profits before tax of £3.9bn. HBOS raked in nearly £6bn. So, okay, Tesco does not expect find itself in the premier league of banks for a while.

On the other hand Alliance and Leicester made £602m profit in 2007. As for the few remaining building societies, the Nationwide enjoyed £781m profits last year, so certainly if Tesco hits its targets it will find itself near the top of the Championship Division for banks and building societies.

The current financial arm of Tesco does not have any mortgages on the book, so it rates as a low risk business.

Moving forward, any well-backed bank which chooses to launch an assault on the mortgage markets will find itself looking at a market-place which is wide open.

Mortgages might not be a good place to be right now, but that will change eventually. Get the timing right, and a massive opportunity awaits.

Tesco also has the advantage that it is not tarnished by the credit crunch. Right now, banks are not popular with the public; a new bank with a recognized brand name can turn this antipathy to its advantage.

The retailer also has its network of stores – it engenders a fair amount of trust among its customers, and of course has a healthy balance sheet.

Tesco is also the type of organization that will benefit from the credit crunch. We may be cutting back on luxury items, but we always need to eat. And Tesco clothes are pretty cheap too.

The credit crunch is a time of opportunity. Companies are going cheap. Financial services companies are pursuing defensive strategies. If you are rich and bold, now represents a time to clean up.

This means of course that sovereign wealth funds find themselves with a chance to buy bargain Britain. But it’s not only overseas businesses that enjoy such an opportunity.

All in all, then, a bold move by Tesco. Then again, there might not be much room in the bed, but while the giants are snoring, or perhaps tossing and turning trying to shake off a nightmare, a nice patch of clean bed beckons Tesco.

PS. Talking of opportunity in crisis: it was revealed this morning that Abbey is now the UK’s top mortgage lender – having overtaken Halifax. It just goes to show what you can achieve in times like these when your parent company is in rude health.

July 22, 2008 | posted by Michael Baxter in Banking | comments (0) |

If you want to know why we have booms and busts then you can do a lot worse than look at that familiar ape -like creature called us. We overreact. When markets boom we jump on, and a kind of mass exuberance exaggerates the boom. When markets tumble, we go the other way.

In his book, Age of Turbulence, Alan Greenspan put it this way: “History is replete with waves of self-reinforcing enthusiasm and despair, innate human characteristics not subject to learning curves.”

Sometimes people emerge with sufficient vision to spot the madness for what it is. Joe Kennedy, father of the late president, famously sold his stock on the eve of the 1929 crash after a cab driver asked for his advice on what stocks to buy. In doing that he proved his shrewd mind.

Sir Isaac Newton was not so astute. He may have been one of the cleverest men ever to have come out of Britain, but he forgot his own laws, and lost a fortune as a result.

When the South Sea Bubble was in full swing, Sir Isaac had one of his sitting under the apple tree moments. “This market has risen too high, it’s bound to fall,” he reasoned. So he sold out. Then he had a change of heart, bought back just before the market imploded. He lost £20,000, a fortune for those days, and is reported to have said, “I can calculate the motions of heavenly bodies, but not the madness of people.”

Yet sometimes the madmen can prove to be quite wise.

When shares in Northern Rock tumbled, many thought they saw a buying opportunity and leapt back in. But, as you know, things just got worse. It was a similar story with Bear Stearns, and more recently it happened with the collapsed US bank IndyMac. Sometimes a seemingly mad sell off can be based on good logic.

So judging madness from intuition can be quite difficult. Which just goes to show it is probably impossible to call top and bottom. And it is impossible to judge investment decisions right each time, but the key lies in being broadly right. Buy when it appears markets have hit bottom, and if they carry on falling, well, in a few years’ time your decision will still probably look quite clever.

So, have bank stocks been oversold?

One would have thought that Dresdner Kleinwort and Morgan Stanley were switched on to be able to identify true value. Presumably they had a good reason to underwrite the HBOS rights issue last April; they clearly thought the rights issue share price was as safe as, well, as safe as houses.

Yet, in the three months or so that followed, the share price halved, and the two underwriters were left nursing their commitment. Did they mess up? Or are they left holding shares that may prove to be very valuable in a couple of years’ time? After all, with another £4bn in the coffers, one assumes HBOS is well placed to exploit the opportunity that is opening up.

As for Barclays, its efforts to raise money at a time of such troubles left overseas investors thinking they had spotted an opportunity. And now the Qatar Investment Authority has a 6 per cent stake in the bank, another Qatari investment vehicle a further 2 per cent stake and the Japanese bank Sumitomo Mitsui a 2.1 per cent shareholding.

For years Britain was on the receiving end of cheap credit from abroad. Cheap credit that helped fund a massive deficit in our current account. But now it is a different story. Britain is going cheap. In the longer term this may well lead to big dividend flows out of Britain that could lead to structural weakness in the pound.

But maybe we should look to private equity for a hint as to how close we are to bottom.

Recently, TPG couldn’t get away from Bradford and Bingley’s fund-raising efforts fast enough. But according to this morning’s FT, private equity outfit Blackstone is looking to buy buy-to-let mortgage specialist Paragon.

Blackstone had the sense to float on the New York Stock Exchange last year before the credit crunch crisis erupted. It also received a healthy dollop of funds from China too, but this was before the great crash in asset values, so it got a nice price for its stock. So, presumably, it’s got a lot of dough in the coffers.

So there is no shortage of shrewd investors who reckon banking shares have fallen too far. They may well be right, but when madness gets a grip it can take a long time before correct valuations become clear. They may yet have a long wait before banking shares reach anything like the highs seen a year or so ago.

It’s a promising sign that Blackstone has seen potential in a mortgage lender, but don’t expect this to represent the end of the financial shocks. When markets are correcting it can take a long time before we finally rid ourselves of the need for an asylum.

July 22, 2008 | posted by Michael Baxter in Banking | comments (0) |

Talking of nerves, one niche player in the mortgage market showed a great deal of nerve recently.

Edeus, which was set up by former HBOS man Michael Bolton in 2006. An auspicious year: 2006 was when the property market was in the midst of a never-ending boom – at least it was never ending if you listened to the property industry, and subprime lending was the new big thing.

The story is about as different now as you could imagine, and that is why Edeus is taking the extraordinary step of encouraging customers to pay off their loans and close their accounts.  If they do comply, there will be an 8 per cent discount and no redemption charges.

Alan Cleary, managing director of Edeus, said: “We need to utilise our capital as effectively as possible to fund our new business ventures.

“Presently, it is proving challenging to do that through traditional channels, such as whole loan trading and the securitisation markets. But Edeus has never been interested in doing things the traditional way. ”

The Edeus deal is being hailed by the company as a win–win situation for the intermediaries who introduced the mortgage customers to the firm in the first place. Customers who want to pay off their loan in the way described, can do so via their intermediary, who then gets the opportunity for a commission on finding an alternative mortgage supplier.

Mind you, one assumes these customers of Edeus will actually find it quite difficult to get an alternative mortgage. If Edeus is so keen to ditch this business, then presumably others will be less than anxious to jump on.

Exiting Edeus customers will also have to pay set up costs with the new mortgage company.

Nerves at the bank may be taut, but frankly, subprime mortgage holders must be finding their tempers are getting frayed too.