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The reasons behind Bradford & Bingley's shocking share price slump

Bradford & Bingley has had a dreadful few months. In the middle of April, rumours arose that the bank was on the verge of launching a rights issue. At the time, B&B denied it strongly. However, within a few days, Royal Bank of Scotland had announced its plans for a rights issue, which was closely followed by HBoS.

With the floodgates open, B&B apparently changed its mind in mid-May, saying it would be raising £300m from shareholders, with new shares placed at 82p a pop, way below the share price at the time.

At the time there was no suggestion of a profit warning, but with the housing market deteriorating, and management under a cloud because of the U-turn, investors were clearly worried. B&B’s share price slumped as investors fretted over the state of the bank’s finances, until on Friday, B&B was trading at just 88.5p a share.

Then, on Sunday, chief executive Steve Crawshaw, whose position was probably already untenable, resigned due to health problems. Then yesterday, the bank finally issued the much-expected profits warning.

And what a warning it was. The group plunged into an £8m loss in the four months to April, compared to a £108m profit for the same period in 2007. Profit margins have dived as funding costs grew, while bad debts have rocketed – more on that in a moment. The group also wrote down a further £89m in sub-prime related assets.

The good news – what little there was – was that US private equity group TPG has picked up a 23% stake in the bank for £179m. But even so, the rights issue had to be entirely revised. Under the original deal, if the share price had fallen below 82p, there would have been no incentive for anyone to buy into the stock and the underwriters (UBS and Citi, the investment banks who undersigned the deal) would likely have been left on the hook for the whole £300m.

Obviously, this wasn’t something either UBS or Citi would have appreciated. Reports in the papers suggest that they might even have found reason to pull out if necessary. So the deal has been changed. Shareholders will now be offered 19 shares for every 25 owned, at the price of 55p a share. Rather than raising £300m, B&B aims to raise £258m.

But why did the other bank shares fall?

The chaos and the grim news on profits sent B&B’s shares diving 24% to 67p, and it’s certainly a messy situation. But why did other banks take such fright? For example, HBoS sank 10%, while Alliance & Leicester fell 5.2%.

Well, the main worries for other banks were in B&B’s trading update. The group – which is Britain’s biggest buy-to-let mortgage lender – saw bad debts on its buy-to-let mortgages jump by a staggering 50% between the start of the year and the end of April. More than 3,000 of B&B’s buy-to-let customers are now at least three months behind in their mortgage payments, from less than 2,000 at the start of 2008. Buy-to-let accounts for nearly 60% of the bank’s mortgage book.

Things will only get worse, said the bank. “The tougher economic environment will continue to push arrears beyond the current level.” As Sandy Chen at Panmure Gordon put it: “This is not the bottom. The UK housing market - not just buy-to-let – is turning south.”

And although the bank has been raising its mortgage costs, it’s not seeing the benefit feed through to its profits, because it can’t write enough of the new mortgages. As Derek Chambers of Standard & Poor’s tells The Telegraph: “I think the hope had been at Bradford & Bingley, probably at HBoS as well, that as they re-priced new mortgages they’d be able to pass on these costs.” But in fact, they are “stuck with more mortgages at low rates which are probably low margin or even negative margin, and they’re not able to free up capital to lend at the new higher rates.”

The trouble is, this is just the beginning of the housing market upheaval. The Bank of England reported yesterday that in April mortgage approvals hit their lowest level since the Bank started recording the data in 1993. Capital Economics reckons the data suggest we could be looking at “house price falls that are well into double digits by the end of the year”.

So all of the banks can expect their bad debts to rise from here on in, for quite some time. Any shareholders in B&B, RBS, or HBoS pondering whether to buy into their rights issues need to forget their current shareholding and ask themselves: “Given the choice of all the stocks in the stock market, would I put my money in a bank right now?”

And for anyone with anything less than the strongest risk appetite, then in the current economic climate, the answer has to be no.

 

This article was provided by MoneyWeek.

Foreign direct investment in plant and factories has swung down over the past year to a negative €149bn (£117bn), including a drop to minus €19bn in March alone as the surging euro drove up relative labour costs in southern Europe. Add in a $280bn withdrawal of private funds from eurozone equities and bonds, and total outflows have exceeded €400bn over the last twelve months.

The euro is now suffering from the “reserve currency curse”, says Ambrose Evans-Pritchard in The Telegraph, as central banks in Asia, Russia, and the Middle East use it as an alternative to the dollar. “While Asian funding has helped ease the credit crisis in Europe, it has also pushed the exchange rate to damaging levels. The eurozone has gained financial flows, but has lost industrial and investment flows.”

BNP’s currency strategist Hans Redeke sees mounting signs of stress. “There are lots of ugly surprises in store as deleveraging finally hits Europe. Investors are going to stop treating the eurozone as if it were just Germany. We will discover in this downturn whether the eurozone is really an 'optimal currency area'. This is the test”.

So, on reflection, maybe this isn’t the time for the Treasury’s great and good to contemplate dumping the pound. And if you’re still unconvinced, here’s what the FT’s Martin Wolf has to say. He’s such a staunch opponent of such a move, he’s even just criticised his europhile peers in print: “the Lex column argued last week that the UK was close to meeting the economic tests for joining. Lex is wrong.”

Three reasons why our currency should be left alone

We’ve not been hurt historically by being out of the euro, says Mr Wolf. Between the first quarter of 1999 and the first quarter of 2008, Britain’s economy expanded by 28% compared with 21% in the eurozone as a whole and 16% in Germany. Nor has London's position as a financial centre been hurt.

In fact, had the UK been a recent eurozone member, our present situation could be even worse. Our credit bubble would have inflated more, because euro interest rates have been lower. On top of that, now that the domestic spending boom is over, there’d have been no offsetting benefit from the recently plummeting pound.

Inflation may well now rise faster in the UK than in the eurozone, but at least we have some hope of controlling this. The Bank of England can set interest rates to suit Britain alone, rather than relying on the ECB, which is arguably far more concerned with how suitable interest rates are for Germany. If the BoE sticks firmly to its 2% inflation target, Britain will almost certainly veer into recession, but then so will the eurozone countries.

So forget the euro - our currency should just be left alone, to find its own level. Which of course, looks like it could well be considerably lower than it is now.

 

 

This article was provided by MoneyWeek.

While you’ll find plenty of commentators who will happily chat in gloomy terms about all sorts of possible problems, and then make a comparison with some point in history, Legal & General has taken the analysis a stage further.

Having totted up all the potential perils facing UK plc, the L&G team then rated each risk on a scale between ‘Good’ to ‘Danger’. Everything in the latter category, you won’t be surprised to hear, is coloured bright red on the heat map.

Why the likelihood of a recession is so high

So after examining sky-high personal debt levels, soaring oil prices, crimped bank lending and tension in the money markets, as well as a few other areas of possible pain, the strategists reckon that the odds of Britain suffering a recession are now about 95%. And what raises the stakes so high is the likelihood that everything will go wrong at exactly the same time. Which also makes it a racing certainty that the recession will prove to be just as bad as both the early 1990s and early 1980s.

How long will it last? The official description of recession by economists is “two quarters of negative growth” (only economists could actually talk about minus numbers as negative growth).

The Legal eagles have been pretty downbeat for some while, but until now have been telling us to expect perhaps two years of the economy going nowhere.

But recently the L&G ‘recession model’ has taken a real turn for the worse, and is now warning of a long decline in economic activity, by as much as 2% year-on-year. That may not sound huge, but if it happens, life could get very unpleasant and we’ll all feel the squeeze.

Cheap Asian imports are getting more expensive

Already there’s lots of talk about the dangers of Asian inflation and what this means for us here in the UK. Instead of picking up all those nice cheap Far East-made goods on our credit cards, we’ll soon find that the prices have gone up quite a lot (see this week’s MoneyWeek for more on this).

But in future, the Legal analysts suggest that little luxuries will soon be off the menu anyway. If we do have any spare credit or cash, we will soon need it just to pay the petrol bill to get to the food store.

Spending in the shops will suffer, profits in consumer businesses will slump and jobs will get cut. Meanwhile, the housing market will get much worse. The Council of Mortgage Lenders now sees house prices dropping 7% this year, with transactions down by over a third on last year.

And banks will become less and less willing to lend money to all those people who’ll need it more and more. Don’t believe we can’t have a recession at this level of interest rates. If the banks close the loan shutters, we can.

Why the Bank of England is a lot gloomier than the Government

It seems the Bank of England is finally catching on, too. Today’s FT reports that the Threadneedle Street thinkers are now a lot more gloomy than official Government forecasts. Indeed the Bank now believes that “a long period of weakness” is needed to bring inflation under the thumb, as I talk about below.

What’s more, the Government, i.e. taxpayers like you and me, won’t be able to do much about helping out, now that Gordon Brown has broken his Golden Rule by reeling in Northern Wreck.

UK public debts have now smashed through the government's official ceiling of 40%, preliminary figures suggest, reaching 43.1% of gross domestic product (GDP) in March. And although Chancellor Alistair Darling has said that any impact on the public finances by nationalising Northern Rock would be "temporary and exceptional", just remember Milton Friedman’s comment that “there’s nothing so permanent as a temporary government programme.”

Historically, governments have been able to use our cash to boost the economy. But Howard Archer, chief UK economist at Global Insight, said the government's aim to keep borrowing down to £43 billion in the current financial year is "wishful thinking" should the economy slow sharply.

 

And because of inflation, the Bank of England won’t be able to help either. The hands of the rate setters on the Bank’s Monetary Policy Committee (MPC) are well and truly tied by the CPI (consumer price index) hitting 3% and looking like it’s going some way higher, rather than lower.

 

In short, there should be no more interest rate cuts on the MPC’s agenda for the moment. Not that they were doing much good anyway. What matters most to the majority of homeowners is the level of mortgage rates. These are priced off so-called swap rates, in turn based on LIBOR – the interbank rate at which lenders lend to each other. Libor rates have stayed stubbornly high, the best part of 1% above base rates, despite the MPC’s earlier antics.

 

This may all sound like a technicality, but it isn’t. What it’s saying is that there’s still a lot of nervousness left in the banking system. Home loan variable rates won’t fall until the markets regain confidence in the Bank’s bank rate.

 

So the picture’s looking bleak on all fronts. Recession looms, consumer prices soar, public debt climbs. Not nice at all.

 

This article was provided by MoneyWeek.

First things first. The latest survey from the Royal Institution of Chartered Surveyors found that 19 in every 20 surveyors reported falling prices in April. That’s the worst reading in the survey’s 30-year history. I probably don’t need to point out that this includes the 1990s crash. Meanwhile, inquiries by new buyers are falling at the fastest rate since Rics began recording the data 10 years ago.

Unsurprisingly, this is all having an effect on consumer spending. The British Retail Consortium reported that the total value of retail sales was up 1.9% year-on-year in the three months to April. That doesn’t sound too bad – but in the quarter to March it was 3.5%.

The “horrific” rise in the price of manufactured goods

But at the same time, inflation is rocketing. The price of manufactured goods rose 7.5% in the year to April, the fastest since 1986. The rise was far greater than City forecasts, and was described as “horrific” by Ben Broadbent of Goldman Sachs, and “nothing short of terrible” by Paul Dales at Capital Economics. Even if you cut out food, alcohol and petrol costs, ‘core’ inflation was still higher than at any time since 1995 (for more on this story, see: UK inflation soars past City forecasts http://www.moneyweek.com/file/46910/uk-inflation-soars-past-city-forecasts.html).

And the breaking news this morning is that consumer price inflation has hit an annual rate of 3%, way higher than the City had expected, and just a tenth of a percentage point away from triggering another letter to the Chancellor. Bank of England governor Mervyn King had better get his pencil sharpener out. We’ll be following up this story on the website later today.

Meanwhile, import prices are climbing too, as the pound weakens. Import prices in the first quarter were up 10.1% year-on-year, reports the FT. “There is a wall of costs waiting out there to dump on the UK consumer,” said Geoffrey Dicks of the Royal Bank of Scotland.

But consumers are spending less, and house prices are falling. That points to falling sales, which makes price hikes a hard sell. And even if prices do rise, rising employment insecurity will mean workers have a tough time demanding higher wages.

Good argument. But as John Plender pointed out in the FT a couple of weeks ago, there is a problem with it. The whole wage-price spiral might not be happening in the developed world. But the developing world – the erstwhile workshop of the world - is another matter.

The end of cheap labour

The global share of the pie taken by labour (the workers) has fallen to a historic low. But now, “emerging market workers are battling for their income share.” When we’re talking about the end of cheap shoes, and the end of cheap vests, what we’re really talking about is the end of cheap labour. That means “the developed world will have to pay more for its imports.”

The other problem, Plender notes, is that even though emerging economies are experiencing rapid inflation (which would usually be bad for the currency – no one wants to be in a currency which is losing value), many are pegged to the dollar. So even though there’s more money around, in dollar terms, it can still buy the same quantity of goods. That puts more pressure on commodity prices as emerging markets gain more purchasing power over “globally traded commodities.”

So developing economies have stopped exporting deflation, and are now fuelling inflation both in raw materials (as they have always done), which is now feeding through to their exported goods too.

Why our government has good reason to seek inflation

And the truth is that here in the developed world, our policy makers have a very strong incentive to pursue inflationary policies. Why? Because our big problem is debt. And inflation decreases the value of debt. Good news if you’re in debt – bad news if you’re a creditor or a saver.

Of course, the flipside is that if the developed world can’t afford to buy all those exports from the developing world anymore, then China and other export-dependent economies could also face rising unemployment and slowing growth. That might take some of the pressure off prices, but would lead to more social unrest with potentially explosive consequences.

So what’s it going to be? Inflation or deflation? In the short term, Mervyn King will have to write another letter or two to the Treasury, that’s for sure. In the longer term, it’s hard to say, and it’s a subject we’ll be returning to regularly in the months ahead – but whichever we end up with, it’s going to be nasty.

 

 

This article was provided by MoneyWeek.