Markets live chat transcript for the chat ending at 12:05 on 25 Sep 2008. Participants in this chat were: Paul Murphy (PM) Neil Hume (NH)
PM:
Welcome to Markets Live
PM:
This is FT Alphaville’s daily market chat
NH:
Why have you got a wet towel wrapped round your head?
PM:
Well spent far to long in LIBOR-OIS space this morning and came out of it too quickly.
PM:
Lead to the release of nitrogen bubbles into my blood which, if not treated, could lead to coma, brain disease and possibly death.
PM:
According to the docs
NH:
Oh, right. And what’s the treatment?
PM:
Well, I had to go back into LIBOR-OIS space for a period and then come out again slowly in a controlled fashion.
PM:
And then wrap a wet towel round my head.
NH:
So do you spend some time with Sonia while you were there?
PM:
You are NOT going to catch me with that one.
PM:
SONIA — Sterling Overnight Interbank Average
PM:
SONIA is the weighted average rate to four decimal places of all unsecured sterling overnight cash transactions brokered in London by WMBA member firms between midnight and 4.15pm with all counterparties in a minimum deal size of £25 million.
PM:
Er, Wholesale Markets Brokers’ Association
NH:
And how does this relate to LIBOR and OIS?
PM:
The development of SONIA – 11 years ago – led to the development of Overnight Index Swaps.
NH:
And made Michael Spencer a great deal of money.
NH:
Of ICAP fame. And what, pray, is an OIS.
PM:
It’s a fixed rate swap against a floating rate index, in a particular currency – like SONIA for sterlign.
NH:
I told Murphy he had to get a handle on this stuff
NH:
Well this is all very RAW, but Norma Cohen – sharp FT hack who now works on the economics desk –has been hearing some interesting whispers.
RAW is market chatter - information that has not been formally tested through traditional journalistic channels (PRs etc). The story might be complete rubbish, but if we believe there is some substance to it we will say so. Either way, Reader Beware.
PM:
You have to take whispers Norma hears very seriously indeed.
PM:
I remember a little over a decade ago she hear a whisper of “ministerial level discussions between the UK and Japan over the state of the copper market…”
PM:
It exploded overnight into what was at the time the biggest markets scandal ever – the Sumitomo affair.
PM:
Copperfingers – old Charlie Vincent — skipped off to Monaco when we got on his case. Great fun story.
PM:
Should quickly say that Mr Vincent was never alleged or proved to have done anything wrong in the Sumitomo case. Just a colourful character.
PM:
Must keep M’learn-eds off my back.
PM:
What’s Norma’s whisper this time?
NH:
Well it is nothing untoward – but intriguing nevertheless.
NH:
Barclays is said to have made a huge trade on the LIBOR-OIS spread exploding wider – and that is precisely what has happened.
PM:
So this is what we might call a “stress bet”
NH:
I don’t know. But that’s what people who understand these things are saying.
NH:
I noticed you put up some pretty charts from this guy at Morgan Stanley earlier
PM:
A five year old could have done those.
NH:
That’s the guy – have you got his note??
PM:
Term LIBOR-OIS spreads have continued to widen today, as the Congressional discussions on the
Administration’s TARP grind on.
Certainly systemic risks are extremely high, and the outlook appears bleak. Spot and forward LIBOR-OAS spreads
are at all-time wides; Bank CDS premia have reached new highs; and term lending markets appear almost to have
closed, while cash hoarding continues, with Fed Funds and overnight sterling trading down as far as they can (0%
and 4% respectively), despite the large pick-ups on offer for term lending.
How can things get better from here? The experience of March-April has some instructive parallels (albeit at less
extreme levels).
In March, around the Bear Stearns debacle, money markets exhibited several of the features present today. The
spread between overnight and 3-month money went negative; and CDS pushed to new highs, taking LIBOR-OIS
spreads to new highs. Overnight CP issuance rose, and 3-month issuance fell.
But government stepped in to take control of Bear’s bad assets, and to support the provision of stronger balance
sheet backing for its counterparty obligations (via its takeover by a large commercial bank). At the same time, the
Fed pumped liquidity into financial markets, introducing the PDCF and TSLF.
In the ensuing weeks, average bank CDS rates fell back, and LIBOR-OIS spreads stabilised and subsequently
narrowed. This, and the return to a positive spread between overnight and 3-month interbank rates, saw term
issuance recover relative to overnight volumes (Exhibits A, B, C).
PM:
Could the kind of recovery that happened in the wake of Bear happen again now?
Certainly there are several similarities. The Fed has again extended the provision of liquidity, both by increasing its FX swap lines and by extending access to Fed financing to a broader range of counterparties and versus a wider range of collateral. The Administration has proposed a facility (the TARP) for taking illiquid assets out of the banking system – a proposal which our US colleagues believe is likely to be enacted in some form. And US financials are gaining incremental capital.
But isn’t the situation now worse than in August? We cannot deny that CDS and LIBOR-OIS spreads are significantly wider than they were in March – and therefore the situation looks now more dangerous than it did then – but it’s equally true that back in March these same spreads were much wider than the peaks seen prior to that point. Indeed in percentage terms, the widening from the prior peaks seen in March were considerably more than they have been this time around, for whatever that’s worth. That said, the collapse in CP issuance this time around is certainly more severe than it was in March.
Progress has already been made. The Central Banks’ liquidity injections have already pulled down overnight rates so that the overnight-to-3-month LIBOR curve is positive again (especially with US and UK overnights trading well below official target rates).
PM:
And our average of major bank 1-year CDS has already fallen by about 35% from its peak of last week. So far, however, risk aversion remains intense; LIBOR-OIS spreads remain very wide; and term lending has collapsed.
PM:
Hang on – I will cut to the chase here.
PM:
So things could look very different by the end of next week: with the money-market curve aggressively steep, and if there is a credible result from the TARP negotiations, and once quarter-end balance sheet issues are behind us, enough banks could find enough confidence that term money markets could revive quite quickly. It’s a credible scenario – albeit one which hinges on a lot of things coming right.
PM:
Here’s a straight forward measure for the LIBOR-OIS spread – dollars.
NH:
You will see that that has rocketed from about 100bp to almost 130bp this week – and in the money markets that is truly seismic.
NH:
And the spread is substantially wider than was seen in March, when Bear got done in.
NH:
Actually Sam did a v v interesting post on this a few mins ago. I think he might even understand it.
NH:
http://ftalphaville.ft.com/blog/2008/09/25/16327/what-price-risk/
NH:
If you look at that you can see that in normal times the rate is in the teens bps
PM:
Just reading that – apparently what we’re seeing now is a 6.2 sigma event
PM:
So Barclays have supposedly made a bundle betting on 0.00004 per cent punt.
PM:
According to Sam’s maths.
NH:
Keep that towel on Murph
PM:
How’s the Footsie doing this morning?
NH:
we are up - 30.7 points at 5,126.3
PM:
Not discussion below abotu the size of the likely relief rally when the MOAB gets the nod
PM:
People really are gearing up for this, no?
NH:
I think we saw most of it last Friday
PM:
I had lunch with a couple of hedgies yesterday
PM:
They are preparing to go v v long selected financials on Monday
PM:
Convinced that the US printing presses are rolling — and cannot now be stopped
PM:
Talking 4per cent on the S&P 500
NH:
possibly, but the entire sector needs to raise more capital and the fundamentals look awful
PM:
I think it is bizarre
NH:
they might sort out there balance sheets but then they have to contend with a massive recession
PM:
Views remain so polemical
PM:
Let’s get into some stock specific stuff
PM:
where’s Monty when you need him?
NH:
talk that Bertelsmann is set to table a 65p a share offer
PM:
really?
NH:
yup, but I doubt it will happen
NH:
well, the deputy chairman of ITV bought 57,500 shares yesterday
NH:
clearly he does not know anything about a bid
NH:
or if he does, he has been incredibly stupid
NH:
that’s Sir George Russell BTW
NH:
Of course, the German’s could be plotting a hostile bid
NH:
but somehow I doubt it
NH:
based on consensus EPS forecasts of 3.12p for 08
NH:
a 65p offer would value ITV at almost 21 times earnings
NH:
who is going to pay that for a media company?
NH:
with the economy about to go in recession
NH:
on top of that there is actually a rational reason for the move this morning
NH:
OK, but it is not very exciting
NH:
So, Ofcom – whose building is on the other side of the road to FT Towers – has published Phase II of the Public Sector Broadcasting Review
NH:
still awake at the back?
NH:
and it looks broadly positive for ITV
NH:
basically ITV is arguing that the level of PSB obligations – regional news, current affairs programmes that sort of thing – are not sustainable in the digital era
NH:
and it seems from OFCOM are supportive of that view
NH:
Here’s a bit of analyst reaction to the OFCOM stuff
NH:
Ofcom has published the second phase of its PSB (Public Service Broadcasting) review this morning. In our view the report looks broadly positive for ITV with support for the revised regional news output as proposed by ITV and a recognition that the current level of PSB obligations are not sustainable for commercial broadcasters post analogue switch-off.
NH:
Today’s publication will be followed by a consultation period and the review will close on 4 December 2008. We expect the final document to be published in early 2009 with any changes taking effect from 2010.
While the PSB report looks supportive for ITV we retain a cautious near term view on the shares ahead of expected worsening advertising newsflow over the coming months. Longer term investors prepared to look at the EPS progression through the cycle are, however, still likely to see material upside in our view. In addition we would not rule out M&A upside given the interest in BSkyB’s stake from strategic buyers.
NH:
Ofcom has previously estimated the overall PSB costs for ITV to be £185m in 2007 against a value of £45m for the analogue licence by analogue switch-off in 2013. ITV has, however, on several occasions highlighted that they believe the PSB costs are significantly higher than the Ofcom estimate as other costs such as minority subsidies (c£25m per year) should also be considered.
Our forecasts already include £40m of savings in regional news programming from 2009E as well as reducing licence costs from the £44m level in 2007 which together limits the estimated PSB opportunity to more like £50-60m in our view. At this stage we have not included any of this potential further benefit in our forecasts given the uncertainty of the timing and phasing of any impact.
NH:
As a reminder we believe the regulatory upside remains very substantial for ITV and while there remains some uncertainty as to the phasing of regulatory change we estimate the overall impact of the four current reviews (CRR, PSB, advertising minutes, product placement) could ultimately be above £100m annually. On a SOTP basis this represents about 25 to 30p per share
NH:
and here’s a backgrounder from Liberum
NH:
tells u what to look out for in the report
NH:
if you have any interest in reading it
NH:
OFCOM will unveil Phase 2 of its PSB review today. It is expected to allow ITV
to go ahead with cuts to regional news services, which form part of ITV’s
Public Sector Broadcasting (PSB) requirements and which could save up to
£40m per annum, despite opposition from trade unions.
It is also expected to present new research pressing for a re-distribution of public
funding to commercial broadcasters for their PSB requirements, including “topslicing”
part of the licence fee to give to other broadcasters.
NH:
While this news would be good in itself, we think the real potential de-regulatory
possibility lies in the likely election of the Conservatives in 1H 2010, whose policy on
broadcasting suggest that they would support significant de-regulation in ITV’s PSB
requirements aligned with an increase in the regulations for the BBC and (to a lesser
extent) Channel 4, which would help ITV’s programming share. In addition, recent
reviews of the potential pricing power of traditional media companies seen as
holding a dominant position previously (the Competition Commission’s research into
Yell in 2006, OFCOM’s review of the radio sector in 2007) has found that traditional
“monopolies” hold far less pricing power than previously assumed, which would help
NH:
ITV’s case for the abolition of the Contract Rights Renewal mechanism, which
regulates advertising prices.
We see this likely de-regulation as acting as an incentive for potential acquirers to
look at being involved in ITV, before some of these potential upside opportunities
are more widely known (particularly with regards to the Conservatives’ plans) with
the sell down of the BSkyB stake from 17.9% to at least below 7.5% and probably
further as the catalyst for action. Our sum of the parts for ITV suggests a price of c.
80p.
PM:
and we should also just repeat Monty’s comments from earlier this week
PM:
in his own inimitable style he poured scorn on the bid rumours
NH:
but he did say that BTL had drawn up plans for a bid
NH:
and there were even code names in place
PM:
I wonder what they are
NH:
as usual beautifully written
NH:
and sadly readers the deal to swap 0.0001 of me (NH) for a Monty has fallen through
NH:
: we can’t afford Monty
NH:
A brief observation on ITV.
NH:
First, an extended process of shuttle diplomacy between Luxembourg and Gutersloh is required to finesse the structural issues that would determine the optimal transaction structure. That has just begun and has some considerable distance to travel.
Second, a delicate assessment is still required of those issues that lie beyond immediate visibility, and frankly rather beyond the control of the ITV boardroom - the outlook for CRR framework change, reform of public service obligations etc. Calibration efforts are ongoing and conclusions far from definitive.
NH:
Project code names have been in existence for quite a while. The scope for reconfiguration of ITV’s business model is well understood. So the business plan is stress-tested, now it is a question of political alignment with Gutersloh and intelligent analysis of an offer structure that would appeal to ITV’s long suffering shareholders. Worth remembering that even ex bid spec, ITV currently trades at a premium to other leading European commercial broadcasters that is exceptionally difficult to justify. No-one wants to look naive in the current market environment.
And that applies incidentally to the scions of the Berlusconi dynasty. The rest my friends is a combination of intellectual laziness, journalistic excess and an unhealthy focus on faded industry executives. The important subject of financing an offer shall remain for another day.
PM:
In my humble opinion anyone punting on a supposed bid story for RSA in this mark is gong to get
PM:
We have heard nothing of value on this story.
NH:
it is on the protected species list
NH:
so why is a bid unlikely then??
NH:
(NEWS FLASH - Collins Stewart talks terminated)
PM:
That’s not a surprise is it
NH:
I guess you think financing for this bid would be all but possible to line up at the moment
PM:
Going into a recession
PM:
I just dont believe it
PM:
RNS should be out by noon
NH:
actually the volumes in RSA aren’t that heavy this morning
NH:
10m traded - if an offer of 220p was on the table I guess vol would be ten times that
NH:
and actually the rest of the insurance sector is in demand this morning
Aviva (AV:LSE): Last: 520.00, up 28.75 (+5.85%), High: 524.00, Low: 485.00, Volume: 2.22m
Prudential (PRU:LSE): Last: 549.00, up 17 (+3.20%), High: 560.00, Low: 530.50, Volume: 2.72m
PM:
Think about what you are writing
PM:
I’m afraid you are becoming a pest
PM:
tried to avoid abusing the readers, but…
NH:
can we get Taxloss and Money to stop abusing me. It’s difficult to type at this speed and keep an eye on the screen and the comments below
PM:
No that’s fun — and legit
NH:
it’s not. making me all self concious and leading to more errors
NH:
still you lot keep me on my toes
NH:
got a price for Lloyds
NH:
just been looking at the spread on the HBOS deal again
NH:
(market in negative territory on GE news)
PM:
GE warning on profits, warning on GE financial — over commercal paper
NH:
25/09/2008 11:32:30 XE !! *GENERAL ELECTRIC CO SEES Q3 SHR $0.43 TO $0.48
25/09/2008 11:32:29 XE !! *GE REVISES 2008 GUIDANCE; REAFFIRMS COMMITMENT TO TRIPLE-A CREDIT
25/09/2008 11:32:28 AX !! *GENERAL ELECTRIC CO SEES Q3 SHR $0.43 TO $0.48
25/09/2008 11:32:27 AX !! *GE REVISES 2008 GUIDANCE; REAFFIRMS COMMITMENT TO TRIPLE-A CREDIT
NH:
25/09/2008 11:33:29 XE !! *BORDERS & SOUTHERN SAYS READY TO DRILL NEXT YEAR; SEEKING EARLY RIG
25/09/2008 11:33:28 XE !! *GENERAL ELECTRIC CO SAYS WILL FURTHER REDUCE FINANCIAL SERVICES
NH:
25/09/2008 11:33:52 XE !! *GENERAL ELECTRIC CO SEES FINANCIAL SERVICES EARNINGS IN THIRD QUARTER
25/09/2008 11:33:49 XE !! *GENERAL ELECTRIC CO SEES FY 2008 SHR $1.95 TO $2.10
NH:
25/09/2008 11:34:23 XE !! *GENERAL ELECTRIC CO REUTERS ESTIMATES Q3 SHR VIEW $0.52
25/09/2008 11:34:22 AX !! *GENERAL ELECTRIC CO REUTERS ESTIMATES FY 2008 SHR VIEW $2.21
NH:
FTSE 100 down 1.3 points at 5,094
NH:
and for a govt backed deal that looks huge
PM:
is it going to fail??
NH:
surely the govt won’t let it
NH:
actually, the spread on the HBOS/Lloyds deal has a parallel in the US
NH:
picked this up from the WSJ last night
NH:
On Sept. 15, Bank of America agreed to purchase Merrill Lynch in a $50 billion all-stock transaction.
The financial landscape has changed drastically since then, what with the Lehman Brothers Holdings bankruptcy filing, Goldman Sachs Group and Morgan Stanley converting into bank holding companies and the government’s bailout plan to allow financial companies to sell toxic assets weighing down their balance sheets.
NH:
While there hasn’t been a shareholder revolt at Merrill over the deal, the stock is trading nearly 9% below the per-share offer price and some have wondered if Merrill made a mistake by selling out at the bottom.
Well, the agreement doesn’t appear to have too many roadblocks keeping Merrill shareholders from walking away. Still, there would be some consequences. According to the merger agreement, BofA has a binding option to purchase, “under certain circumstances, up to 19.9% of [Merrill’s] outstanding common shares at a price, subject to certain adjustments, of $17.05 per share.”
UBS analyst Glenn Schorr wrote in a research note, “We don’t see a breakup fee, but BAC’s purchase option brings up to $5.2 billion to Merrill and a $2 billion gain to BAC, a financial win for BAC and dilutive to Merrill.” He noted that, “given wider collateral acceptance at the Fed and bank facilities, the potential [Resolution Trust Corp.]-like government solution and the ban on short selling, which could help capital raises, we think Merrill holders may be less interested in seeing this deal happen.”
NH:
It isn’t uncommon to amend deals. The sale of Bear Stearns to J.P. Morgan Chase in March was renegotiated to $10 a share from the original $2-a-share agreement. Of course, Bear shareholders stood to lose a lot if the J.P. Morgan deal didn’t happen. J.P. Morgan had clauses in the merger agreement stating that, if shareholders rejected the deal, J.P. Morgan had an option to buy 20% of Bear for $2 a share and could buy Bears’ midtown Manhattan headquarters for $1.1 billion.
“In looking at the bailout, Merrill has to ask ‘does the package get us out of hot water?’,” says Marc Pado, U.S. market strategist for Cantor Fitzgerald. “What if the package offered by the government is such that [Merrill] looks at it and decides they never needed to be bailed and should remain stand alone?”
Still, Pado said canceling the deal is more difficult than traders may think. For one, if Merrill backed out, the company would come under much of the same trading pressure on Wall Street as before and still couldn’t survive in the same structure as it was a week ago.
PM:
So are we looknig at a shareholder revolt at HBOS??
NH:
I am hearing some might
NH:
Aegon are apparently unhappy with the deal
NH:
but it is a bit of game of Russian roulette
NH:
If the deals fall through, HBOS shares could be worth next to nothing
NH:
of course if the MOAB works they could sail on
NH:
anyway, I am not sure the govt will countenance any protest
NH:
apparently they have told the fund management community that if they don’t back the deal
NH:
: then life could be made very difficult for them
PM:
if anyone has theories on why the spread has blown our, other than the fact banks shares cannot be shorted
NH:
market holding up well, given that GE have just unleashed a profits warning
NH:
down just 10 - as Monkey says we may have to look at the credit market for a more sane view
NH:
Stacy is on the phone at the moment so we can’t get a Markit quote on CDS’s
NH:
before we move on from Lloyds
NH:
there is a note out on the stock this morning
NH:
but before we come to that - great post from Monty - the exchange ratio was obviously too generous. I am worth much less
PM:
ONE-MONTH DOLLAR LIBOR 3.71% VERSUS 3.43%, BBA SAYS
*OVERNIGHT LIBOR FOR EURO LITTLE CHANGED AT 4.38%, BBA SAYS
*THREE-MONTH DOLLAR LIBOR 3.77% VERSUS 3.48%, BBA SAYS
*THREE-MONTH STERLING LIBOR 6.28% VS 6.20%, BBA SAYS
*THREE-MONTH LIBOR FOR EURO 5.11% VS 5.06%, BBA SAYS
*ONE MONTH STERLING LIBOR 5.99% VS 5.91%, BBA SAYS
*OVERNIGHT STERLING LIBOR 5.08% VS 5%, BBA SAYS
PM:
ratching higher again
PM:
As BQ says — not a healthy financial system
NH:
and the market is down JUST 15 points
NH:
Am i missing something
NH:
GE can’t borrow at anything approaching profitable rates in the CP market
PM:
Despite all the liquidity being pumped in
NH:
and yet the equity market thinks nothing serious is happening
NH:
obvioulsy coz the MOAB is going to ride to the rescue and solve all of the world’s financial ills
NH:
sell note out this morning, could be responsible for some of the weakness
NH:
in fact the Satanic analyst in question has actually downgraded it
PM:
Who is responsible for this
NH:
and he makes the quite reasonable point
NH:
that putting these two companies together
NH:
does not make them any easier to fund
NH:
here’s the executive summary
NH:
Good: market share and synergies; less good: capital, credit, funding
We believe Lloyds TSB’s acquisition of HBOS will create a UK bank with virtually
unassailable market share and that management will beat synergy expectations by
> 50%. However, putting two banks together makes funding more difficult,
increases exposure to property lending, and we expect will lead to a 5.6% starting
core tier 1 ratio. Though Lloyds TSB is trading at 5.5x current pro-forma earnings
including synergies, a return to 1992 loan losses and share issuance to achieve a
6.5% core tier 1 ratio would place the stock on 22x. Sell, target price 200p.
NH:
Credit risk, capital, purchase accounting
The acquisition of HBOS will give Lloyds TSB a strong market position and access
to synergies which, taxed and capitalised at 8.5x would justify £9bn of the £12bn
price tag. However, in buying a much larger bank (HBOS’ loan book is twice as
large as LTSB’s), LTSB is importing HBOS’ problems. Funding for the merged bank
will be harder to raise, not easier, given counterparty limits. LTSB is taking on an
additional £334bn of property-related lending and we estimate that purchase
accounting adjustments will see the bank £4.5bn of capital short of a 6.5% core
tier 1 ratio (despite including LTSB’s capital raised on Friday 19 September 2008).
NH:
Short-term EPS and capital concerns
Short term, we expect risks over loan losses and balance sheet recapitalisation
sheet by equity issue or asset sale will trump the very significant synergy benefits
of the acquisition. If we add together our standalone forecasts for Lloyds TSB and
HBOS and factor in the £1.5bn of synergies we believe are achievable, the
combined group is trading at 5.5x 2009 earnings. However, adjusting for a
potential return to 1992-level loan losses and for capital raised to return the
combined group to a 6.5% core tier 1 ratio, places the share on 22x 2009 EPS,
falling to 15x in 2011 on delivery of full synergies.
NH:
Medium-term upside
Given these concerns, we expect the shares will trade to 200p, a 30% discount to
our estimate of current tangible net asset value per share of 280p. If management
are able to produce significantly higher capital ratios in the short term, by asset
sales, capital increase, or both, we would see fundamental upside to the shares
based on medium-term earnings. However, given the downside to our target price
we downgrade to Sell from Hold. Key upside risks include an improvement in the
UK economic outlook, improvement in debt and equity market conditions and/or
the capital accretive sale of a significant part of the merged group.
NH:
I think he means menace to society
NH:
anyone, clearly pure evil
NH:
and CFA is obviously the new 666
PM:
Lloyds getting smashed now
NH:
in fact the Lloyds note is part of a bigger piece of work on the UK banking sector from the sinner Napier CFA
NH:
and it is a very interesting read
NH:
he says for all the talk about de-leveraging, the big capital raises from Barc, RBS and HBOS
NH:
capital ratios have not improved
NH:
in fact they are at the same levels as December
NH:
and that’s before losses on corporate loans start to kick in
NH:
his conclusion is that we are going to see further capital raises
NH:
Sector leverage hasn’t fallen, the economy is weakening, loan losses to rise
Despite a year of talking about delevering and raising £21bn in fresh equity, the UK
banks reported pro-forma tangible equity/total assets of 2.2% at June 2008, in line
with Dec 2007 levels. Loans and financial assets continue to grow faster than
capital and quicker than customer discretionary income. Affordability of property
assets in the UK remains weak. We look to avoid lower capital ratios and weaker
loan portfolios. Buy Barclays, Sell Lloyds TSB/HBOS and Bradford & Bingley.
NH:
Banks haven’t delevered and neither have their customers
The UK banks have raised £21bn in new equity in 2008 which has helped
shareholders funds grow by 7%. However loans grew by 8% and financial assets
by 15% leaving tangible equity/total assets at 2.2%, equal to the level at the end
of last year. We believe that while the potential US superfund could draw a dotted
line under the first “act” of the banking drama – risk assets – two significant
episodes have yet to be played out: higher loan losses consistent with a European
recession and increased regulatory capital requirements.
NH:
The credit cycle may require further capital increases
With liquidity conditions still troubled, banks generally as levered as before, and
customers showing a deteriorating capacity to repay debt, we expect property
prices to fall further, arrears to rise, bank losses on default to rise and consensus
earnings expectations to fall further. Given the environment we believe that Lloyds
TSB/HBOS in particular should take steps to bolster its regulatory capital base.
Stocks to Buy, stocks to Avoid
Barclays is our top pick: The capital raised last week and the acquisition of
Lehman Brothers’ US business below book value propels the core tier 1 ratio to
~7%, combined with a loan book which is least exposed to commercial property
of the UK domestics. Trading on 6x 2009E we regard the share as inexpensive
relative to its prospects. Buy, TP485p.
NH:
Lloyds TSB is a stock to avoid we believe. We estimate a starting core tier 1 ratio
of 5.6%, 68% of group loans in property and construction, a significant wholesale
funding requirement and relatively exposed to accounting and regulatory capital
pro-cyclicality we believe the group would benefit from raising at least £4bn in
new capital. Sell, TP 200p.
Sector valuation and risks
The UK banks are trading at 8.4x 2009E EPS, a small premium to the European
banks on 8.1x. The UK domestic banks are trading on 5.3x, half the multiple of the
UK international banks, HSBC and Standard Chartered. The domestic banks are
trading at 2.2x pre-provision profit and 1.5x tangible book value per share. Our
stock target prices are generally derived using a sum of the parts approach, as
detailed in the individual company pages in this report.
We see the risk of higher than expected loan losses as the key factor facing the
sector. As described in this report, a return to peak loan losses would reduce our
2009 earnings forecasts for the sector by almost half and eliminate almost all
earnings for the likes of A&L, B&B, HBOS and RBS.
NH:
got another bearish note on Lloyds
NH:
this sinner has set an even lower target price
NH:
Jonanthan Pierce of Credit Suisse
NH:
Lloyds TSB - a “bargain purchase”?
NH:
The new group has a capital deficit of around £10bn, on our estimates
■ Terms might still be altered, in HBOS favour
■ We continue to rate both HBOS and Lloyds TSB Underperform
NH:
Following the acquisition of Bank of Scotland in 2001, Halifax went on a bold
strategy of growing assets far more quickly than deposits - the transformation
was so significant that by 2007 its loan to deposit ratio was within touching
distance of the old BSCT. That, it seems, has cost it its independence.
For Lloyds TSB shares though, the question is whether the disproportionate
transfer of HBOS equity to its shareholders, combined with the synergies,
offsets the risks it is taking on. In the medium term, this might be the case, but
on a 6-12 month view, we would not invest in Lloyds TSB.
NH:
The equity tier 1 ratio, at 6.0% pro-forma June 2008E, is vulnerable to the
strict fair value assessment that accompanies bargain purchases, i.e.
where consideration < net assets. Further HBOS Treasury marks could
reduce the ratio by 40bps, on our estimates;
• We believe the combined group could experience a 25%+ uplift in RWA as
the cycle turns. That would reduce equity tier 1 by 120bps, on our numbers;
• In 2012 (and potentially earlier) 50% of the 190bps contribution to equity tier
1 from financial subsidiaries will drop out;
• We estimate the combined group will have a £420bn wholesale funding
requirement with a loan to administered rate deposit ratio of at least 180%;
• We estimate around £100bn of wholesale funds will be <1 month maturity,
although we believe theres a highly liquid pool of assets of £75bn which
provides a lot of comfort;
• In both nominal and proportionate terms, the combine will have more
exposure to UK specialist mortgages, UK credit cards, UK personal loans,
and UK commercial property than any other UK bank all the assets we
worry about, aggregating £200bn+ or 7 times the tangible equity base.
NH:
Overall, we think the combined group might face a capital deficit of around
£10bn in time. The high LTD also demands rapid de-leverage at a time when
retail and deposit growth is falling sharply, in our view. We think fixing both will
be expensive for shareholders. At 1 times tangible equity (ex in-force) we
cannot get excited. We take Lloyds TSB 12-month target price to 195p (from
220p) and HBOS to 165p (from 330p) and both remain on Underperform.
PM:
Think that deserves a bickie
Reminder to readers - if you arrived late and want to stop the dialogue ‘jumping’ as you catch up, hit the ‘pause auto-scrolling’ tab at the bottom right hand corner
NH:
looks like Lloyds share price is really sensitive to Libor moves
NH:
Stacy do we have an accurate Libor-IOS reading pls
PM:
She’s trying to get one
PM:
If that is correct for US $ then the spread has exploded
PM:
er, i think
NH:
I bet the equity market is up now
PM:
Store of value - Zim-style
NH:
things aren’t too bad
NH:
ah, now down just 7 points
NH:
Collins Stewart not faring so well though
NH:
shares down 7.75p at 61p
NH:
Tracy has just gone to get the LIBOR-OIS spread from the Bloomie
NH:
there I have got it right
PM:
Stacy even
PM:
We cant find it. apols
PM:
B&B — will be a penny dreadful soon
PM:
Bradford and Bingley trading at 22.75p, down 2.25
PM:
Barclays has had to take over guaranteeing its covered bond
PM:
Apparently, the authorities are very keen to protect the integrity of the covered bond market
PM:
Dont want it to suddenly become uncovered
NH:
Bryce just sent this over on the Bungle Bank
NH:
It’s a bet about “who” will bail out not “if”
NH:
After all, holding positions in Bradford & Bingley means
betting on who will bail out this bank, not if it will be bailed
out. Certainly, Santander could have a strategic interest in
taking over the bank and further increase its footprint in the
UK (ING and some Australian name that is currently rumored
seem to have less strategic opportunities);
NH:
however,
we are still talking of speculation, nothing has been confirmed
or denied yet. At the end of the day, nationalization
seems also likely, as the cost stemming from this action by
far outweighs the inherent cost associated with the dramatic
loss of reliability and trust in the UK banking segment.
Against this backdrop and in view of the solution
found for NRBS, we feel that the adjustment of the support
rating could have been performed a little earlier; however,
maybe the more market-like solution found for HBOS was
needed by Fitch to verify the willingness of the market and
the regulators to provide support
NH:
Impact on covered bonds…
The downgrade to below A-3 at S&P triggered a segregation
event. The actions to be taken are as follows:
● The servicer of the loans which currently is Bradford &
Bingley itself has to be replaced within the next 60 days.
● The loan files have to be moved physically to the LLP.
● The asset coverage test ACT has to be examined and
signed by the asset monitor KPMG
NH:
However, this is just one effect on the covered bonds. The
downgrade of the senior rating by Fitch to BBB- in combination
with the D-Factor of 9.1% only qualifies for a covered
bond rating of just AA-. Assumed an outstanding recovery
rating for Bradford & Bingley’s cover pool of between
91% and 100% - which might already appear a little
high given the large share of buy-to-let with all associated
features like high share of interest only and high LTV ratios
– allows for a AA+ rating. Hence, de-facto awarding a
watch negative on the AAA rating of the covered bonds
simply means that we are expecting a downgrade within
NH:
the next few days: A major problem and de facto the kiss of
death.
… and cross effects back to the company
through the BoE SLS – the kiss of death
One if not the only remaining liquidity source for Bradford &
Bingley is the Special Liquidity Scheme of the Bank of England.
According to the scheme, covered bonds are eligible
under the following criteria:
● Mortgage or public debt out of UK and EEA
● AAA rated by at least two rating agencies
● Issued by the institution, or entities in the same group as
the institution, entering into the transaction.
So far, BRADBI covered bonds are rated
(A1wn/AAA/AAAwn), which qualifies them as collateral for
the SLS. However, if BRADBI lose its second triple-A rating,
the last ray of hope will be extinguished
NH:
Conclusion
The downgrades, which actually should have happened
already some weeks ago, seem to be turning out the light
for Bradford & Bingley. The covered bonds will soon no
longer be available for the SLS which – in our view – will be
the final step until Bradford and Bingley will be saved by a
white knight. The good news is that we strongly believe that
a knight will appear; whether the knight will come from Madrid
or from London or just somewhere across the channel
is still open – and probably of minor importance. The main
thing is that it better be riding a fast horse.
NH:
(Thanks Taxloss. Determined to get the ratio up to 0.001 before the end of the month)
NH:
Lloyds now biggest faller in the FTSE 100 - full steam ahead captain.
PM:
Think what the price would be in a free market
PM:
Okay — got to wrap up now
PM:
Thanks for all the lively comments this morning
PM:
And Zoomy — sorry if i was a bit harsh
PM:
We will be back at 11am tomorrow morning
