Can A&L survive credit crunch?

Dec 5 2007 by Alistair Houghton, Liverpool Daily Post

Lingering doubts make for an uncertain future. Alistair Houghton reports

WHEN Northern Rock was brought to its knees in September, speculation was rife that other banks faced the same fate.

The thousands of depositors who queued to withdraw billions of pounds of savings caused the first run on a British bank since 1866.

With the credit crunch crippling world financial markets, and banks everywhere finding it difficult to raise the funding they needed to back their mortgage books, many in the financial services industry openly speculated about who might be next?

Alliance & Leicester, which employs 2,000 staff at its business banking base in Bootle, found itself labelled as the hot favourite to be the “next Northern Rock”.

Its share price performance in recent weeks has been more volatile than that of most other banks, largely because it is more dependent on the troubled interbank market than many other lenders.

This creates similar liquidity issues for A&L to those which caused Northern Rock’s troubles.

City analysts agree A&L faces tough and uncertain times over coming months as the credit crunch keeps its grip on the financial world. Indeed, some fear it could get worse.

However, the important difference between Northern Rock and A&L is the latter has so far been able to support its finances without resorting to the Bank of England for assistance. In a trading statement last week, A&L tried to relieve fears by saying it had secured the wholesale funding it needs into the third quarter of next year.

The funding, understood to include £4bn from Credit Suisse, was not raised from the traditional interbank market, and A&L is remaining tight-lipped about the cost of it.

The bank said: “Alliance & Leicester is maintaining strong asset quality while delivering growth and good cost control.”

As well as the Credit Suisse loan, the company also plans to increase its reliance for its funding on its own customer deposits rather than the interbank market. However this is likely to constrain it’s growth potential.

The statement added: “Against an anticipated backdrop of slower economic growth and a smaller UK mortgage market, we expect the rate of growth in our interest earning assets to slow in 2008.”

At first sight, the statement appears to have done the trick. On the day of the announcement, A&L shares rose by as much as 14%, with the group becoming the FTSE’s top performing stock.

Yet the concerns linger. Ashley Stuart, an analyst at JP Morgan, said the positive news from Alliance & Leicester did not alter his opinion that mortgage providers were in for a tough ride.

He said: “News of the funding facility is likely to move the stock up in the near term but there is nothing in the statement to change our view that 2008 is likely to be a tough year for the mortgage banks and 2009 probably even harder.”

In its statement, A&L confirmed its deposits, together with its new funding packages, covered its loan book.

It said: “The total of customer deposits, together with committed wholesale funding with a maturity of over six months, now exceeds our £55bn of customer loans and advances.”

Carl Cross, investment director at fund management firm Rensburg Sheppard in Liverpool, offers some hope. He said that, unless the markets took a massive turn for the worse, banks such as A&L and Bradford & Bingley should be able to ride out the credit crunch.

He said: “Northern Rock is an unusual example. The others should be reasonably able to continue in business without too many problems.

“If we reach the point where those banks are having runs on them, à la Northern Rock, we would have reached a material problem with the banking system which will lead to real problems everywhere else.

“That would mean a complete collapse of the banking system, which would be economically shocking and decimate other areas as well. Our assessment is that’s pretty unlikely.”

In a slowing housing market, with fewer people looking for mortgages and with financial institutions reluctant to back mortgage banks, A&L is looking to win more customers to deposit savings at its branches and online.

BUT that, analysts say, will prove difficult simply because other banks are trying to do exactly the same.

James Hutson, analyst at stockbroker Keefe, Bruyette & Woods, said last week’s statement had given A&L a “reprieve” from market speculation, but warned growth was likely to remain slow.

“This was never a stellar growth stock anyway, but it’s less so now,” he said. “What we see is that their wholesale funding position is now secure through to the third quarter of next year,” he said.

“What it doesn’t do is engender much confidence about the new volumes they will be chasing over the next 12 months. They have said they will be reliant on deposits rather than wholesale money to fund asset growth.

“Many other banks will be pursuing a similar strategy. There will be competition for deposits.

“In the absence of wholesale funding, A&L’s growth may be stymied. We are going into a period where we’ll see more pedestrian rates of new volume growth.”

A&L’s future stability, under chief executive David Bennett, depends on the direction of the interbank mar- ket in the year ahead. It needs things to return to pre-credit crunch normality in the foreseeable future.

But, just this week, one of the rates at which banks lend to each other soared to its highest level in almost nine years as fears grew of a New Year interbank liquidity freeze.

On Monday, the interest rate for one-month Libor – London interbank offered rate – hit 6.72% from 6.09% on Friday as banks rushed to secure cash ahead of the year end. That compares to the 5.75% base rate.

With A&L now having to borrow huge amounts on the interbank market, analysts are questioning how much it may have to pay in interest – and how much that could affect its profitability.

Analyst Tom Rayner, of Citigroup, said: “A&L has rallied on the back of the announcement that it has pre-funded its maturing medium-term funding, commercial paper and certificates of deposit into the third quarter of 2008, achieved partly through the raising of additional funding, which we understand to be on an interbank basis collateralised against A&L’s mortgage assets.

“While this is reassuring in terms of liquidity, A&L has had to operate outside the normal public markets and it is not clear at what price this has been achieved.”

Danny Clarke, Liverpool-based analyst at Shore Capital, said: “A&L’s statement said there were a number of funding arrangements arranged. We believe that £4bn from Credit Suisse is an element of that.

‘WE DON’T know how much that’s going to cost on an ongoing basis. The cost of that may be fairly painful if they need to use it.”

Mr Cross added: “Banks will try to make their money from that interest margin. If there’s an element of liquidity crisis which pushes up the cost of borrowing, and competition which requires them to push up their rates to attract savers, it’s easy to see how profit can be affected.”

Mr Cross said the impact of the credit crunch on the UK banking system had been less than predicted, as shown not only by reassuring statements last week from A&L and Bradford & Bingley but also by investment bank Barclays reporting that its write-downs stood at £1.3bn, less than the £10bn some in the City had predicted.

He said any rally in share prices in the banking sector would depend on whether the future of the housing market became clearer over coming months. “Earnings visibility is unclear and the markets demand visibility,” he said.

“Potentially, it’s a little like catch-ing a falling knife. You’ve got to watch out or you could get badly stung in the short term. If there’s a housing market crash then all bets are off.

“We anticipate bumpy times ahead, but hopefully contained. But, if the worst happens, it’s got ramifications for the whole economy and not just the housing market.”

A&L has launched a massive redevelopment project at its Bootle base which will see the landmark office tower block disappear.

Unlike that particular 1960s tower block, it looks like A&L will, for the time being at least, remain a feature of the region’s business landscape for many years to come.

alistairhoughton