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The bank turning crisis into opportunity

Created:

30 October 2008

Written by:

John Adams

The government's £50bn recapitalisation of the UK's banks, and the provision of a huge pool of liquidity, might have stabilised the banking sector for now. But ministerial insistence that banks will continue to lend at 2007 levels - notably to small businesses and mortgage borrowers - doesn't chime well with the view coming from the Bank of England . In its latest Financial Stability Report the B ank points out that banks need to cut their reliance on wholesale funding. They can do that by bulking up on customer deposits - which isn't likely in a recession - or "through slower lending growth".

Specifically, the Bank believes that if lenders are to reduce the funding gap - the difference between what they get from customer deposits and what they need from wholesale sources - to 2003 levels, then "customer lending (to both domestic and overseas borrowers) would have to slow significantly". And far from being the great panacea to keep banks lending, central bankers appear to view the government's banking sector intervention as simply a move to help "smooth this slowing in lending".

It's a scenario that hardly bodes well for long-term bank earnings. With a recession in full swing, earnings will be hit from both rising bad debts and a fall in net interest income as they rein in their new lending. And should the government insist on a round of politicised lending to keep the economy moving, then the outlook is just as bleak. That could mean a pile of non-performing loans that bash earnings and eat up precious capital.

But at least one UK bank looks set to emerge from the pain looking better off - Lloyds TSB. The bank, which has spent years looking for a credible growth strategy after competition regulators blocked its plan to buy Abbey National in 2001, is on the verge of snapping-up HBOS. It's a deal that would have been unthinkable before the banking crisis hit. After all, it will leave Lloyds with a 29 per cent share of the UK's mortgage market and a 35 per cent slice of current accounts. The Office of Fair Trading (OFT) would never have allowed a single lender to grab so much market clout in normal times. But, for the sake of saving the financial system, Gordon Brown has pushed competition concerns to one side.

True, HBOS' shares, at 85p, are trading well below Lloyds' implied 109p-a-share offer price - in normal times that would cast doubts over the viability of the deal. But in these troubled times, and with the government convinced that the deal is essential to stabilise the banking sector, failure looks unlikely. And that premium doesn't mean Lloyds is overpaying, either - far from it. Analysts say that HBOS's tangible book value stands at around £20bn, but Lloyds is paying just £5.9bn. Moreover, the overlap between two major high-street banks is large enough for the synergies to be impressive. Lloyds expects to make £1bn in savings from the deal, but analysts at Panmure Gordon this week estimated that synergies could turn out to be nearer twice that much.

Certainly, the near-term attractions of Lloyds - or any UK bank for that matter - aren't great. Like all lenders, it will struggle in a recession and, with the government set to take a 40 per cent stake in the combined entity, don't expect cash dividends for years to come. But, in the longer term, the scene has been set for Lloyds to emerge from the current turmoil as the dominant force in UK banking.

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