HBOS detractors jump the gun

HBOS rights issue: Nailing the blame game

HBOS is now the UK’s second-biggest mortgage lender after Spanish-owned Abbey claimed 25% of the market in the first half of 2008. The Scottish bank is trading well below book value, and reported in its half-year results, a drop in profits of 58% year on year. A £4 billion ($8 billion) rights issue fell flat with all but 8% of shareholders (see Bank rights issues: A right mess of issues, Euromoney, August 2008), and there are hefty funding requirements. Over the next 12 months, HBOS has more than $20 billion in corporate bonds, securities and medium-term notes reaching maturity.

As a result, there has been a lot of talk about a possible break-up of the bank, with names such as JPMorgan, Santander and National Australia Bank being floated as possible consortium members in an ABN Amro-style break-up. But many market participants are sceptical that such a deal will materialize. Although Santander has shown its UK market credentials with the performance of Abbey, and NAB would welcome HBOS’s Australian arm, it is considered unlikely that any will want to take on HBOS’s balance sheet difficulties. "The biggest hindrance for anyone looking at HBOS is funding its balance sheet," says a banker familiar with the troubled lender. "That is almost a poison pill."

In March last year, HBOS issued a €2 billion senior unsecured deal at five basis points over mid swaps, and in October the bank issued a €1.25 billion covered bond at three. These contrast sharply with HBOS’s current funding levels.

In June, the bank was paying 125 bp for unsecured funding and 70bp for covered bonds.

Expensive exposure

HBOS’s problem is not mismanagement or overly aggressive lending but simply that it is so exposed to the UK property market and that the funding markets are so expensive. The challenge for HBOS will be to continue drawing profits, and to show the world that the existing management can run the business as well as any potential suitor. In terms of battling rising funding costs, though, there might not be an answer. "We are seeing big credit problems hit the UK market," says an analyst. "What can be done about that is not obvious. There is very little that you can change in the short term."

HBOS will therefore continue to operate in a more challenging environment. The rights issue received bad press but the bank still got its capital. Funding costs have risen to worrying levels but the bank has had no problems meeting its first half-year financing requirements. The Bank of England’s special liquidity scheme (SLS) is an option. Indeed, HBOS tapped it for £9 billion in April.

"Despite the market dislocation we have seen an increase in funding from the wholesale markets," says Richard Shrimpton, head of capital at the bank’s treasury. "[But] although we have issued £9 billion of term funding this year, asset growth will continue to be selective as we reduce our reliance on wholesale funding."