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).

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).

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.

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.

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.

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.

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.”

“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.

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.

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.