Markets live chat transcript for the chat ending at 12:08 on 23 Jul 2008. Participants in this chat were: Bryce Elder (BE) Neil Hume (NH)
But that still means that Morgan Stanley, Dresdner and the sub-underwriters have been stuffed with 62%, worth £2.6bn.
I would say ouch. But here’s the real feat.
As I understand it, neither Morgan Stanley or Dresdner will emerge with a disclosable stake in HBOS, viz a stake of 3% or more.
How so? Well after the rights closed at 11am on Friday, they were both allowed to take a short position in HBOS, to cover themselves against a future fall in the HBOS share price.
So they duly shorted HBOS in massive size. I understand Morgan Stanley took a 2.4% short position in the mortgage bank – which is huge.
Clever old Morgan Stanley and Dresdner have won brownie points from HBOS for not wobbling during the fund-raising, even though it was blowing a gale in markets
But here’s what I find a little bit odd – that they were allowed to short HBOS’s shares, at a time when the market was unaware of the full extent to which the rights issue had flopped.
On Friday, Dresdner and Morgan Stanley both knew that existing shareholders had shunned the rights issue, since they were organising the share sale. But the market was only given the information this morning.
That information was – in theory at least – highly price sensitive. You’d think therefore that both Dresdner and Morgan Stanley would be banned from dealing in HBOS on their own account till the market had been told the extent of the rights take-up.
But apparently no such prohibition applied. Which reinforces my view that the current rules relating to rights issues are – to put it mildly – utterly bonkers.
Morgan Stanley sold HBOS stock to these hedge funds, by creating short positions for its own book.
In this way, it went short to the tune of 2.3 to 2.4% of HBOS’s equity.
And because HBOS’s share price enjoyed a strong surge on Friday, Morgan Stanley took out this short at a very attractive average price.
And the short is just big enough to reduce Morgan Stanley’s net shareholding in the enlarged HBOS to a fraction below the 3% disclosable limit.
So the US investment looks very smart.
For Morgan Stanley, the fact that it was responding to orders from clients, rather than soliciting those orders, is terribly important.
It feels that it can’t be accused of profiting at customers’ expense from its privileged position as joint lead manager of HBOS’s rights issue.
That said, Morgan Stanley was in possession of valuable price sensitive information, at the time that it went short of HBOS.
It knew – and the market didn’t – how much of the underwriting for the £4bn rights issue had been placed with long-term investors likely to hold the HBOS shares that would be forced upon them, and how much of the underwriting remained on its own books.
Also, Morgan Stanley would have known that the rights issue had flopped (though at the relevant time it would not have known the precise number of HBOS investors who had spurned the share sale). But that debacle was blindingly obvious to all professional investors, so was probably less of an advantage.
To reiterate what I said yesterday, I am persuaded that neither Morgan Stanley nor Dresdner (which also shorted HBOS) broke the rules.
But if you or I had known what Morgan Stanley knew and had shorted HBOS on Friday, we would probably be prosecuted for alleged insider trading.
So the rules – and the City’s custom and practice – that allowed Morgan Stanley to go short to the tune of something like £250m look archaic and in urgent need of reform (along with much of the rest of the apparatus and antiquated regulations surrounding how our companies raise equity capital).
Here are a couple of extra relevant details.
1) The traders at Morgan Stanley putting in place the short last Friday from 11am onwards were not given official information about the scale of the rights flop.
2) Senior management at Morgan Stanley did not learn the grim details of the flop – that as little as 8 per cent of the rights shares had been taken up by shareholders – until shortly after 4pm on Friday.
With HBOS, it was only after the rights issue closed that the direct short position was taken. By that stage, it was widely assumed in the stock market the rights issue had flopped, though only Morgan Stanley’s client relationship team would have known quite how badly. Even if the traders responsible for the short position had been able to take a peep over the Chinese wall to see the full damage – the issue was only 8.3 per cent subscribed – it would have made no difference to their actions. As it is, Morgan Stanley insists there was no such snooping.
The laughable part of this everyday story of City money-making jiggery-pokery is that, were it not for new FSA rules requiring the disclosure of short positions, no one would ever have known that the trade had taken place and it would by now already have been lost in the mists of time.
The quid pro quo for the repeated bailouts the banking system is receiving from the taxpayer right now is meant to be a greater degree of oversight and accountability, on practice as well as bonuses. Bankers must at least show contrition if they are to avoid regulatory over-reaction. The trouble with the Morgan Stanley short is not that it was against the rules, but the way it looks.
Have I hedged myself sufficiently? Good. For, as it happens, I believe July 15, 2008 will turn out to be as good a date as any to mark the end of the long, painful bear market financial stocks have endured for the past 18 months. And more to the point, it marks the beginning of the greatest financial stock bull market in our lifetime, one that will be much broader than the bull market that began in 1990.
But if you understand what drives stock prices, and have an investment time horizon of at least one year, feel free to keep reading. And if you are a patient value investor, get out your highlighter and get ready to buy stocks.
With the gap between current market values and business values so wide, investors shouldn’t even worry too much whether July 15th was indeed rock bottom for the stocks. The margin for error today is so wide that any investor with at least a one-year horizon and a little analytical ability can pick huge winners. We wouldn’t buy across the board, but the vast majority of the depressed financial stocks will survive, recover, and deliver high investment returns from these levels.
Financial services investors had a lot to deal with last week. Do you recall? On Monday, they grappled with news that regulators had closed IndyMac the previous Friday. It was the third-largest bank failure ever. Also over the weekend came word that the Treasury Department and Fed had drawn up plans to stabilize Fannie Mae and Freddie Mac.
It was momentous-sounding news—but, if you think about it, not necessarily negative. IndyMac’s failure couldn’t have been a surprise, thanks to Sen. Schumer. And the prospect of a stabilized Fannie and Freddie should have been seen as a positive, both for the economy and other financials. Even so, investor angst rose and, on Monday, the XLF, an index of large-cap financial stocks, dropped by 5%, closing on its low.
GM suspends its dividend.
Retail sales for June come in lower than expected.
The dollar hits a record low against the euro.
June PPI comes in higher than expected.
Long lines ring IndyMac branches, as depositors of the failed bank seek access to their funds.
A popular bear, Meredith Whitney of Oppenheimer, lowers her rating on Wachovia to “underperform,” citing the company’s bleak prospects.
Bloomberg runs a story reporting that private equity investor TPG has already seen its spring investment in Washington Mutual cut by two-thirds.
CNBC interviews its new favorite investment guru, Bill Ackman, about his plan to “save” Fannie and Freddie. Ackman, who admits he just shorted both companies, describes a plan that would wipe out common shareholders of both companies.
In all, it was pretty scary stuff to deal with in a highly fragile market.
So what happened next? The following events on the 15th stand out as being especially significant, in my view:
Financial stocks decline dramatically in the first 45 minutes of trading. It was an across-the-board collapse. Citigroup, which closed at $16.40 on Monday night, traded as low as $14.02, a decline of 15%. Wachovia, the subject of Whitney’s downgrade, was off by 20%.
The VIX hits 30.82 in the first 45 minutes. The VIX is of course everyone’s favorite measure of investor nervousness. Recent readings above 30 have signaled a peaking in the level of panic.
First Horizon’s stock rises at the open, despite all the bad news. First Horizon, a heavily shorted banking company, had moved up its earnings release to Tuesday from Thursday after seeing its stock decline 25% Monday over fears about its survivability. After the company released an earnings report that showed it was far from spinning out of control, its stock opened up 5%–despite the panic in the financial sector. The stock closed up 14% on the day.
Financial stocks stage a dramatic turnaround in the morning before closing lower on the day. For example, the XLF, after its initial 5% decline, rose 9% from the trough, but still closed down 3% on the day.
An incredible volume of shares trades. On July 15th, 469 million shares of the XLF traded, eclipsing its previous one-day volume record, set the prior Friday, by 150 million shares. This record would fall two days later when 528 million shares traded. July 15th will be a day to remember!
Beyond the highly volatile, dramatic trading patterns that happened on the 15th, conditions for a turn seem to be in place that will be familiar to anyone who’s lived through a market extreme before.
Long-term company valuations are extremely depressed. Before trading began on July 15th, many financial services companies were trading at valuations wildly out of line with their long-term earnings prospects–simply because of excessive investor fear. The fear has come about from the very real credit problems that have developed over the last 18 months, and the unrealistic expectation that they will persist indefinitely into the future.
With the banks stocks off by 50% in the last three months alone, investors seem to have been stunned into inaction, while bearish momentum investors have piled on their shorts. Rational analysis about companies’ long-term prospects has given way to the simplistic notion that chargeoffs must go higher, so stock prices must go lower. As a result, many financial stocks are significantly undervalued relative to their long-term earnings potential.
Bearish analysts have devised new methodologies to justify current or lower stock prices. Just as tech analysts rolled out new valuation methodologies to justify sky-high stock prices at the peak of the tech bubble in 1998 and 1999, bearish financial services analysts have developed new “methods” to “value” financial stocks to avoid recommending them now.
They are nothing if not resourceful. One analyst, for example, estimates a bank’s entire future losses, deducts that number from tangible book value, then assumes the bank raises additional capital at current (highly dilutive) prices. Then he assumes the stock should trade at or below that estimate of pro forma, adjusted tangible book value. Potential book value growth from future earnings? A return to normal valuation? That counts for nothing.
Clearly all the analyst wants to do is come up with as low a number as he can, whether it makes sense or not, in order to justify his bearish position. This isn’t “conservative” analysis. It’s poor analysis.
So who are the new media darlings? One is Bill Ackman, a man with a mixed track record at best. To show how crazy the current environment is, he shorts Fannie and Freddie on Thursday and Friday and then calls CNBC to tell them he has a plan to “save” the companies, which (what a coincidence!) involves a complete wipeout of common shareholders. And CNBC takes him seriously! None of the financial journalists who interviewed him on July 15th questioned his true motivation.
Then there’s Meredith Whitney, who last year raced to become the most bearish bank analyst on Wall Street. She published her latest report last week and held a conference call with investors on July 15th. Her new angle: stay away from bank stocks because future credit losses will be much higher than they think. Why? Well, Meredith discovered that the home-price futures that trade on the Chicago Merc are forecasting greater price declines than the banks expect. The futures market on which Whitney hangs her entire report has an open interest of all of 435 contracts, with a notional value of—are you ready?—$17 million. Since when do equity analysts rely on new, illiquid market pricing to do their forecasting?
In fact, I think second quarter earnings results are providing encouraging signs that the credit problems won’t turn out to be as great as widely feared, that not as much dilutive capital will need to be raised, and that fewer companies will have to cut their dividends. For example, despite its strong recent bounce and better-than-expected second quarter earnings, Bank of America stock still yields 8.7%.
Second quarter earnings reports are so far encouraging. While commercial banks have mostly been the ones to report earnings so far, their reports have been encouraging with respect to credit quality. I’m specifically referring to changes in delinquency rates, slowing inflow of new non-accruing loans, and the lack of meaningful increases in criticized assets.
Even the accounting for credit problems is improving, as companies have tightened up on the classification of loans 90 days past due but not on non-accrual. Banks seem quick to take writedowns on non-accrual loans and are aggressively building reserves.
It is by no means clear sailing from here. Even so, the stocks are significantly undervalued under all but the harshest economic scenario. The evidence from second quarter earnings to date is that that scenario won’t come close to happening
premium to XTA.
in precious metals business.
picture of the previous day’s session in the American Banks
was revealed by the overnight scans
which create the raw material used here?
The scans showed a pattern of
unprecedented intra-day volatility, an initial high
volume fall of 5%, a subsequent rally of 7.5%, the close 5.25%
below the day’s highs, a final fall on the day of 4%, all
accompanied by the (almost) highest ever daily volume
came into being around March/April last year.
Throughout all attempts to rally had been regarded here as
of low quality and unsustainable.
The strong downward trends quickly reasserted themselves.
The subsequent rally from last Tuesday’s intra-day lows
has been extraordinary in terms of its extent and speed,
and is shown below.
terms of quality than its predecessors and has gone
further in extent than might have been anticipated – it
certainly represents more than the merely short covering – inspired move
that was originally thought.
Can anything useful be said now?
It is not yet possible to know whether last Tuesday’s action
represented the final capitulation which so often marks the lows
in markets / sectors / stocks.
But one thing is clear.
level at which the buyers on a number of occasions made their stand.
The breach of that level in May was serious
and was commented on accordingly, proving its seriousness
by creating a breakdown of 30% in the sector in as
many days.
This important level will represent serious
resistance to the advance of the last few days.
We would, therefore, expect to see consolidation around this level,
probably lasting a month or so, allowing
a clearer picture to emerge as to whether last Tuesday
marked the nadir of the massive Financials – related
bear market which began to develop last Spring.
where the scale of the advance in recent days is much more
muted than that of the American Banks:
we believe the ultimate lows have not yet been seen.
Bounce per hapsRNS Number : 6611Z
Vodafone Group Plc
23 July 2008
23 July 2008
SHARE REPURCHASE PROGRAMME
The Board of Vodafone Group Plc (“the Company”) has considered the market reaction to the Group’s Interim Management Statement, issued on 22 July 2008, and has decided to introduce a £1 billion share repurchase programme with immediate effect. This action reflects the Board’s belief that the share price significantly undervalues Vodafone.
Shares will be purchased on market on the London Stock Exchange in accordance with shareholder approval obtained at the Company’s Annual General Meeting (“AGM”) in July 2007 and subject to the renewal of that approval at the Company’s AGM on 29 July 2008.
Follow-up to yesterday’s disappointing trading update
Vodafone shares fell some 14% yesterday following a disappointing trading update. This more than reversed its brief rally against the All-Share since 30 June; year to date, Vodafone shares have now fallen 31%, in line with the telecoms sector (in Euros) and against “only” 17% for the All-Share. Over the past 12 months, the shares are now down 20% comparable to the All-Share and compared with 24% for the European telecoms sector.
Background:
The main focus yesterday was weakness in Spain where revenue growth reduced from 5.1% in Q4 to a decline of 2.5% in Q1. Against our forecast, this represented a “miss” of around 5% with Spain representing around 14% of group service revenues.
Vodafone’s new revenue guidance suggests around a 1% cut to its previous outlook with the implication being that Spain represents around 0.7% of this reduction. We estimate that the remaining reduction is slight weakness in the UK, lower equipment revenue (which should boost margins) and marginal reductions from Emerging Markets.
Estimate changes:
We will move to 1% below the mid-point of Vodafone’s new revenue guidance, adjusted for currency. This gives 2008/09 revenue of £40.15bn, a reduction of 1.4% from our previous forecast.
For operating profits, we will move to the bottom-end of Vodafone’s range of £11.0-11.5bn i.e. £11.0bn and assume currency strength only offsets any incremental trading weakness. This represents a reduction of 2.5% from our previous estimate of £11.28bn.
This gives EPS including amortisation of 13.3p (a reduction of 2.7%) and EPS ex amortisation of 16.5p (a reduction of 2.0%). A 60% payout ratio would imply a dividend of 8.0p.
Vodafone’s new guidance is based on underlying organic revenue growth of “around 2%” compared with 1.7% in Q1. This suggests that Vodafone is not assuming any further deterioration in Spain nor that this weakness spreads to other markets as macro conditions continue to get worse.
Perhaps understandably in current markets, investors are concerned that this is only the first of several reductions to guidance. In our view, yesterday’s weakness reflects this uncertainty and the reduced visibility.
Reasons to be more positive:
Vodafone has been very transparent with yesterday’s statement. Management’s confidence in the full year outlook reflects its view that Spain is an isolated issue given its exposure to migrant workers and more variable spending patterns. Other European markets (including UK and Ireland) were in line with expectations and Telefonica appears broadly comfortable with expectations for its own Spanish performance.
Vodafone is launching new revenue initiatives and stresses cost flexibility to fund these initiatives (and also therefore to offset any further revenue weakness by implication).
US remains robust, at least in terms of subscriber additions with Verizon due to report this coming Monday (and AT&T later today).
Currency remains supportive with current spot rates implying a 2% future upgrade to Vodafone’s revenue outlook.
Valuation – remains very attractive:
On our new estimates for 2008/09, Vodafone trades at 4.3x EBITDA, 9.7x PE (including amortisation) and 7.8x PE (excluding amortisation) with a dividend yield of 6.2%.
We value Vodafone’s stake in Verizon Wireless at 45p per share using a 10% discount to the 8.3x EBITDA Verizon has agreed to pay for Alltel, plus a 20% tax rate. Stripping this out of Vodafone’s valuation would imply Vodafone’s core business is valued at below 7x PE (excluding amortisation) with a dividend yield of 9.5%.
The following illustration provides a “back of the envelope” calculation to stress test the risk to forecasts from here.
Extrapolating the 5% Spanish “miss” to 100% of group revenues would translate into a revenue reduction of £2bn.
Assuming a gross margin of 75% (as in 2007/08) would imply a £1.5bn reduction in gross profit.
It seems fair to assume some of this could be offset by further cost reductions. Assuming a 5% reduction to operating costs below the gross margin line (est. £15.5bn in 2008/09), would imply £775m of cost reductions.
This would imply operating profits could be reduced by £725m compared with the £280m indicated above. This would suggest a further fall of 4% is possible.
This would translate into further EPS reductions of around 4-5% over and above those indicated above, implying EPS including amortisation of 12.7p and EPS ex amortisation of 15.9p (a reduction of 2.0%). These “bear case” scenarios would still suggest EPS and DPS growth of 1-2%, albeit supported by currency.
Summary thoughts:
Given the possibility of further revenue and perhaps profit downgrades, it is difficult to envisage Vodafone shares staging any immediate and sustained recovery (and also not helped by the consensus buy recommendations that existed before yesterday). However, the valuation remains compelling and our stress testing suggests only limited EPS downside. As a result, our recommendation remains OUTPERFORM, although investors may need to take a long term view.
expect the stock to bounce and found a trading range between 130 to 140p in the
short term. The share buy back is less than 30% of the amount of the dividend
they paid last year. It is important to bear in mind that Vodafone has the
capacity according to our numbers to take the share buy back to GBP3.5bn.
Currently 1bn shares is about 4 day of trading and obviously this should
provide clients who want to sell/short with even more available liquidity.
Longer term this is a stock which will trend downwards over the next 6 months
as the economy further restricts the consumer.
Morgan Stanley & Co. International plc
Nick.Delfas@morganstanley.com, Saroop.Purewal
Upgrading to Equal-weight as we believe Vodafone’s shares now discount an extreme decline in
FCF from being seen as a ‘growth’ stock — our price target of 170p implies 33% upside potential.
Our chief concern is that fiscal 2Q will be worse than fiscal 1Q in Spain, but we have now reduced
our forecasts below guidance on revenues. Our second concern is MTR newsflow in October,
but set against a share price that already prices in significant declines in returns in Europe for
other reasons, this now appears less relevant. Third, consensus for 2010 looks high (8% above
us), but a reduction is now likely discounted. We see the new CEO, Vittorio Colao, taking over as
a key positive. FT (price €19.80), DT (€11.08), KPN (€10.46) and Tele2 (SKr 113.5) are our top
picks, with lower cyclical exposure.
By Toby Shelley in London and Roman Olearchyk in Kiev
Published: July 23 2008 03:00 | Last updated: July 23 2008 03:00
Shares in Cadogan Petroleum were suspended yesterday, just a month after the company floated in London.
The company became the latest victim of perceived legal risks of working in Ukraine, Cadogan’s sole area of operation, as a lawyer for Nadra Ukraine, the state-owned natural resources company, said it was taking action “to return interests that were wrongfully stripped away”.
In June Cadogan floated at an offer price of 230p, with an implied market capitalisation of £532m, but the shares have traded below that level since.
On Monday its market capitalisation was £341m, with the share price at 147½p.
There had been speculation in the Ukrainian press that a local court had questioned the validity of two of Cadogan’s gas development licences. The case was not brought against Cadogan, the company said.
Cadogan said it was fully confident in its titles to the assets and would contest vigorously any claim to the contrary. It added that joint venture operations with Nadra were continuing as normal.
Cadogan learned of the hearing only when news of it was posted on the internet on Monday afternoon. The company then began investigating the reports.
But speaking to the Financial Times, Viktor Pankov, chief lawyer at Nadra, said his company’s interest in the licence areas had been diluted through “manipulations” identified by a state oversight agency.
He said: “Our position is to return interests that were wrongfully stripped away from Nadra … which has in the past invested sizable funds to develop this field.”
Cadogan has proven and probable reserves of 80m barrels of oil equivalent. Commercial production from the Pirkovskoe field began this month and production at the Zagoryanska field should start next year. However, these are the licences cited as being in legal doubt.
Cadogan is not the first UK-listed oil and gas company to be frustrated in Ukraine. Regal Petroleum’s licences were challenged in court – one of the factors leading to the company’s share price collapse in 2005 – and JKX Oil & Gas battled for three years to defend its position. Nonetheless, gas production in Ukraine is particularly attractive. Russia, which supplies much of the country’s needs, has pushed up the price of gas, allowing Ukrainian producers to follow suit. Cadogan said when it floated that it expected Ukrainian domestic gas prices to reach parity with western Europe in the near term.
both declined to comment.
More like 1973 than 1989?
‘Deep value’ investors are taking more of an interest in
UK property shares. This is understandable given our
share price targets imply ‘only’ -17% further downside to
our estimate of the trough for UK property shares.
However, we think that there is an increasing risk that
the current cycle turns out to be more like the mid-1970s
than the late-’80s/early-’90s, in which case there would
be considerably more downside to UK property shares
than we currently assume. Nevertheless, shares do not
fall in a straight line forever, even in the worst of bear
markets, and we think that in the short term UK property
shares may be overdue a ‘bear market rally’, particularly
relative to the broader stock market in the UK.
If the fall in UK property shares were to match that
during the late-’80s/early-’90s downturn, then we see
‘only’ -11% further downside in real terms from today’s
levels. However, if they were to match the downturn of
the mid-1970s, then we calculate there would be -54%
further downside in real terms from today’s levels. With a
-17% average downside to our price targets for UK
property shares, to a presumed trough in UK property
shares at end-2009, our current position is much more
closely aligned with a late-’80s/early-’90s scenario than
a mid-1970s one.
As the ‘credit crunch’ progresses, we think some uncanny
similarities are emerging between today’s situation and that of
the mid-1970s. Firstly there is the very severe reduction in the
availability of credit. Secondly, there are the bank failures, such
as Northern Rock and Bear Stearns over the past year, which
offer significant parallels with the UK’s secondary banking
crisis of the mid-1970s. Thirdly, both periods experienced
sharp rises in oil prices. Fourthly, both periods experienced
‘stagflation’ – rising inflation (which suggests interest rates
should be raised) while the economy stagnates (which
suggests they should not). Finally, as far as the UK property
investment market is concerned, both periods experienced
extremely low turnover in the property investment market.
…although admittedly there are some big differences
Admittedly there are some big differences between today’s
situation in the UK and that in the mid-1970s. Firstly, today we
do not have very high inflation. Secondly, we currently do not
have widespread industrial unrest, with the miners’ strike back
then at one point necessitating a three-day working week.
Increasing risk that this is more of a 1970s scenario
However, taking everything into consideration, we think that as
time passes there is an increasing risk that the current
downturn becomes more akin to the mid-1970s one than that
during the late-’80s/early-’90s.
A lower trough to UK property shares under a 1970s-style
scenario could plausibly come about through a combination of
worse outcomes than we are currently assuming for any of the
three key determinants of property share prices: rents, yields
(which together determine NAVs) and the discount to NAV at
which the sector troughs.
Shares do not fall in a straight line
However, share prices do not fall in a straight line forever, even
in the worst of bear markets. So far during the current UK
property share bear market, the UK property sector has fallen
significantly more rapidly relative to the broader equity market
than at the same point during either the late-’80s/early-’90s or
the mid-1970s bear markets (see Exhibit 2). While we retain a
Cautious view on the pan-European property sector, including
UK property shares, on a 12-18 month view, we think that in the
short term UK property shares may have fallen too far, too fast,
particularly relative to the broader equity market.
Trigger could be margin erosion elsewhere
One of the consequences of stagflation is that the pincers of
falling sales and rising costs substantially erode margins of
non-financial companies, resulting in lower earnings, lower P/E
ratios and hence lower share prices. With non-financial
companies starting to be squeezed in this way, we think that
UK property shares might outperform the broader UK equity
market in the short term.
Indeed, in addition to low mortgage activity, latest survey evidence shows that agreed house sales are very low, buyer interest is weak, it is taking longer to sell a house, and sellers are achieving a falling percentage of their asking price. All these factors point strongly to further declines in house prices.
Consequently, Global Insight forecasts house prices to fall by 15% in 2008 and 12% in 2009. As a result, house prices are seen falling 26% in nominal terms from their August 2007 peak of £199,600 on the Halifax measure to stand at £147,478 at the end of 2009. Reduced falls in house prices are expected in the first half of 2010, taking them down to a low of £140,104, which would be 30% below their August 1999 peak. House prices are then seen flattening out in the latter months of 2010.
views on the Monetary Policy Committee (MPC), with both proving to be ardent and unashamedly
vocal hawks and doves, respectively. The former sees the need to anchor inflationary
expectations as paramount, while the latter regards the pick-up in inflation as entirely
temporary with the looming slowdown in growth approaching with seemingly gathering menace.
With this in mind, the three-way split in voting revealed by the minutes of the July MPC
meeting released this morning may well have been eye-catching, but ultimately should not be
viewed as especially surprising.
This is the first three-way split in voting seen since May 2006, a fact which neatly
illustrates the pressures imposed upon the inflation-targeting regime by the peculiar nature
of the current downturn. But a focus upon the centre ground rather than the ‘outliers’
seems more pertinent here, and these minutes suggest that a more hawkish tone appeared to be
developing amongst the more silent majority of the Committee this month. Indeed, with the
wish to avoid surprising financial markets proving to be a key argument against hiking in
July, and with the August Inflation Report seen to be providing a better opportunity to
explain any hike, it seems that the majority of the MPC may have been hardening behind a
move at the beginning of the month.
To a certain extent, however, a more hawkish tone was to be expected from these minutes.
Bad news had emerged on rising inflationary expectations, the oil price was touching record
highs on a daily basis and the renewed bout of financial market turbulence – most openly
expressed by rising fears around the health of the US mortgage market – was only just
gathering pace. The Committee will also have received an advanced draft of the June CPI
release, showing a further an unexpectedly large rise in headline inflation. On the basis
of this evidence, a greater degree of spare capacity was now seen as being required to
offset the upside surprise on inflation, and the question now is whether sufficient bad news
has emerged since July 9th/10th to calm the MPC’s nerves.
Certainly, financial market sentiment remains fragile and the fall in oil prices of recent
weeks will be welcomed by central banks around the globe, while business and consumer
sentiment surveys continue to deteriorate. Data released by the British Bankers Association
this morning showed mortgage approvals to have fallen significantly further from an already
extremely weak level in May (now down 67% in the year to June), while reports of house price
declines are also increasingly commonplace.
Clearly, the market will now scrutinise tomorrow’s retail sales data and Friday’s Q2 GDP
figures with greater tenacity, but overall we believe that the further bad news on the
growth front that Committee were looking for earlier this month has, on the whole, been
delivered. On a more fundamental point, we continue to argue that developments within the
labour market will prove crucial to the MPC’s thinking over the coming months, given that
wage developments offer the most convenient conduit for commodity price pressures to be more
widely dispersed across the economy. With this in mind, the data of recent months from the
labour market – supplemented by more downbeat news on employment in the Bank of England
agents report out this morning – continue to argue that the threat of a wage-price spiral
developing over the coming months remains essentially theoretical at present.
Overall, therefore, we continue to seen interest rates being left on hold during the
remainder of this year before an easing cycle begins in the early months of 2009. But it
should nevertheless be seen that with the risks to the economic outlook increasing on both
sides of the equation, the task of policymakers is turning ever more difficult and increased
conjecture around the likely path of interest rates should as a consequence be expected.
From a broader perspective, the difficulties being faced by highly-leveraged house-builders are likely to have a negative knock-on effect on the wider UK house-building market. Struggling LBOs may choose to aggressively discount their properties for-sale in an effort to improve short-term cash flows, forcing competitors to follow suit and therefore compounding price falls. Additionally, the lack of land buying and the possibility of distressed land sales by LBOs will further dampen land prices, in turn
Following HBOS’s difficulties with its rights issue last week, and the release of
Bank of England (BoE) data for May, we are reducing our forecasts for UK
residential loan growth for 2008-10. The risk we see to our estimates remains on
the downside, especially with inflationary pressures potentially reducing scope
for lower base rates. We believe the increasingly evident UK economic
slowdown and the steady stream of negative newsflow represent a short-term
headwind for all UK Banks sector shares. We are not yet convinced that the H1
results season will be a catalyst to restore sentiment and higher UK Banks
sector valuations in the short term.
us that business or asset disposals may now be the only option remaining for UK
banks wishing to bolster their capital ratios. With fewer options, we now expect UK
banks to adopt an even more cautious approach to asset growth.
Growth in UK residential loans outstanding slowed to 7.9% y-o-y in May (source:
BoE, 30 June). This was slightly below our forecast of 8.0%, and follows 8.4% y-o-y
in April and 8.8% y-o-y in March.
We are reducing our 2008 UK residential loan growth forecast from 5.5% to
4.8%. The annualised m-o-m growth has been just 4.5% now for the last two
months. Furthermore, the scope for UK base rate reductions in 2008 may have
decreased, and some UK banks may now adopt an even more cautious approach to
loan growth following the outcome of HBOS´s rights issue.
We expect the slowdown to continue at a moderate pace beyond 2008 (Chart 2).
We now forecast loan growth of 4.5% in 2009 (previously 5.0%), 5.0% in 2010
(unchanged) and 5.5% in 2011. In the last UK property downturn (1990 onwards),
annual loan growth remained above 4% in spite of falling house prices (Chart 1).
(excluding HSBC and Standard Chartered). This is 2 standard deviations away from
the 15 year average forward P/E of 11x (Chart 3) and compares with a European
Banks sector on a rolling forward P/E of 8.1x.
However, it may still be too early for a sustained recovery in UK Banks P/E ratio
since (a) consensus EPS shows no signs yet of stabilising (Chart 4), (b) earnings
visibility remains poor due to further potential fair value adjustments and asset
disposals, and (c) newsflow and sentiment may remain negative, especially in
relation to UK property prices and the banks´ diminishing options for raising capital.