Here’s what Deutsche Bank are telling their clients regarding Northern Rock on Friday:
As the most leveraged bank in Europe, with assets to equity of 58x, a modest reduction in Northern Rock’s net interest margin has a significant impact on the group’s profitability, sustainable returns and valuation. If we assume that Northern Rock’s cost of deposit funding converges to its cost of wholesale funding, driven by a re-pricing of NRK’s deposits and increase in wholesale funding mix, we estimate that the normalised cost of funds is c22bps above base rates compared to our previous estimate of 16bps. This reduces the normalised return on tangible equity to 10%. Conventionally, a bank earning cost of capital ought to trade at book value. Current tangibleNAV per share is estimated at 439p.
We retain our Sell recommendation given the risks of a sustainable and significant increase in the cost of funding for the bank. However, until more detail on the term and size of the potential liquidity provision are made clear, our target price remains under review.
And here’s what Credit Suisse have to say:
At this stage, we think any attempt to value Northern Rock on 2008 earnings is pointless. Resorting to the Bank of England as a lender of last resort effectively means Northern Rock will, at least for a period, be running the bank in “safe mode”. We expect new mortgage lending to slow sharply, and asset growth to stop or even go backwards in the near term.
Even before the Bank of England announcement, secondary market spreads suggested writing new mortgage business was barely profitable anyway…We suspect spreads will widen out further as a result of this announcement.
Before the credit issues emerged, we had forecast 82p annuity EPS at Northern Rock in 2008. Assuming no net asset growth next year (versus our 17% and group target 20%) but otherwise stable conditions our forecast would be at least 10-15p lower.
Going one step further and assuming that the balance sheet actually shrinks 25% as redemptions flow through, that would be another 15p on our estimates. In other words, EPS could be considerably below 50p next year in our view, even if things steady out…
In the near term we believe Northern Rock will be valued as a distressed asset and attention will turn to the book value.
Northern Rock’s reported equity includes preference shares and intangibles (capitalised software costs) and excluding these we get to 445p tangible ordinary equity per share.
And this is from JPMorgan Cazenove:
The lack of new business flow and a penalty cost of funding will have a detrimental impact upon Northern Rock’s earnings. We estimate H2 pre-tax profit, excluding gains, will be c.£165m compared with £254m in H1. This implies a 15% cut to FY2007E underlying pre-tax profit and there is limited visibility over 2008E earnings but annualising H207 earnings implies an EPS of c.40p compared with our current estimate of 89p (adjusted, diluted).
In our view, Northern Rock is unlikely to remain independent but the value of the company to an acquirer may be significantly below the current share price.
Assuming a 50bp spread on the mortgage book, 50bp on the deposit book and an ongoing cost/income ratio of 35%, we estimate that an acquirer would gain an earnings stream of £224m post tax. This is consistent with revised H207E earnings annualised. On 10x, and with a 20% discount (eg. integration costs, asset impairment) this values Northern Rock at 424p. Northern Rock’s book value as at 30th June was 462p but this could be vulnerable to a run on the £24.35bn retail deposit book.