The bank reporting season has kicked off with tales of some real howlers. Alliance & Leicester is the latest lender on the rack...
Welcome to the latest ABC of banking bungles.
Within the last week we've already seen two mini-disasters, with buy-to-let lender Bradford & Bingley
(LSE: BB.)
unveiling halved profits and Credit Suisse forced to suspend several traders suspected of overvaluing assets by £1.5bn.
Today it's the ‘A'. Mortgage lender Alliance & Leicester
(LSE: AL.)
has just admitted a two-thirds profit plunge, while junking its earlier earnings forecast.
Not that you'd know about the latter without wading through the lengthy results document. But down in the depths of Page 15, amidst all the self-congratulatory waffle that increasingly characterises bank reports these days, is the following confession:
"In the light of unprecedented conditions in the financial markets since August 2007, our previously announced target of growing underlying basic earnings per share by at least RPI+9% from 2006 to 2009 is no longer appropriate".
In other words, Alliance and Leicester won't be making as much money as it had thought as funding costs are likely to surge. And for the six months to 31 December, profits have taken a real tumble, plummeting by 67% to £73m.
But reckless mortgage lending isn't to blame. At the interim stage six months ago, Alliance and Leicester claimed that mortgage quality remained excellent. The lender still reckons that focusing on high-end customer lending is paying off.
With good reason. Mortgage write-offs were a mere £1m last year, and with just 0.5% of mortgages over 3 months in arrears, slightly down on 2006, A&L is faring much better than the Council of Mortgage Lenders' end-2007 average of 1.2%.
What's more, Alliance and Leicester's average loan-to-value ratio for the residential mortgage book was just 46% at the end of 2007, so not too many of the lender's customers are likely to be facing negative equity and handing back the house keys.
Nor is there a personal loans problem. The proportion of unsecured advances in arrears at the year-end was lower than December 2006, allowing a £12m cut in the Retail Banking bad debt charge to £85m for 2007. And only 0.46% of commercial lending balances were over 30 days in arrears at the end of December 2007, down from 0.6% at the end of 2006.
Even now, Alliance and Leicester says there are no sub-prime, near-prime or self-certified mortgages on its balance sheet.
So what's been the problem?
The real damage was done by what has become the same old story...asset write downs. Yet again, US investments made by a financial institution have turned out to be worth rather less than the values in the books. In this case, by almost £200m.
To be fair, A&L had had marked investors' cards in November that all was not well with its portfolio of CDOs (collateralised debt obligations) and SIVs (structured investment vehicles), pools of mortgage loans that have been packaged up and financed through the money market.
Yet today's news still appeared to shock investors, as the lender's share price went for an early 18% bath, before rallying to a less dramatic 10% decline. And over the last twelve months, the picture is truly awful, with Alliance and Leicester undershooting the FTSE 100 index by over 50%.
With the final dividend being maintained at 36.5p per share, the bank is on a trailing price to earnings ratio of 8 and now yields a gobsmacking 11.6%. There's no doubt the stock looks cheap at first glance, though I seem to be saying the same about quite a lot of banks at the moment.
But relying on the capital markets for half its funding makes A&L vulnerable to any future money market mayhem. Yields tend not to stay double-digit for too long. Either the share price rises, or the dividend gets cut. The latter looks more likely to me.
And the banking alphabet still has a long way to run. At the risk of missing a buying opportunity, I'm happy to let the dust settle before applying my cash to buying Alliance and Leicester.
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