By Ian Fraser
Published: Sunday Herald
Date: 29 June 2008
Analysts admit Scottish banking giant’s low market valuation is ‘getting silly’
OVERWHELMINGbacking last week for HBOS’s £4 billion rights issue is being seen by analysts this weekend as a turning point in the Scottish bank’s fortunes. Thursday’s vote, in which 98% of shareholders supported the initiative, may mark the beginning of the end of the credit crunch troubles that have turned the Edinburgh-based institution into Britain’s most beleaguered large bank.
The green light came even though the bank’s share price has plunged below the price at which shareholders are expected to buy “discounted” shares.
At 275p each, the discounted shares probably looked attractive on April 29 when the two-for-five rights issue process was announced. At that time HBOS’s share price was 495.75p. This meant that shareholders would have been able to buy additional shares at a 45% discount. Now it looks increasingly likely that underwriters Morgan Stanley and Dresdner Kleinwort will end up having to buy £4bn worth of new shares for a price higher than their actual value.
But research into analyst sentiment by the Sunday Herald found a turning of the tide in HBOS’s favour. Many are now prepared to agree with Lord Stevenson, HBOS’s chairman, that a “disconnect” has emerged between HBOS’s share price and its likely financial performance in both 2008 and 2009. HBOS’s shares have collapsed by 76% since February 2007. Having peaked at 1153p on February 23, 2007, they closed on Friday at 275p.
The valuation of the shares by the market suggests investors believe the UK is about to enter a long and painful recession as bad as, if not worse than, that seen in 1990 to 1992. If such an Armageddon scenario, which would include a 20% to 30% fall in UK house prices and a surge in unemployment, were to transpire, HBOS would be in serious trouble. Retail and corporate borrowers could be expected to default in droves.
However, James Eden, an analyst at Exane BNP Paribas, argued that such a scenario was very unlikely. “With the HBOS share price languishing at 275p, I would agree that there is a disconnect between economic reality and the share price. I hope I’m right, because the sort of economic scenario implied by the current share price looks pretty ugly.”
Alex Potter, an analyst at Collins Stewart, said HBOS’s current share price reflects an assumption that there would be a 1990s-style recession in the UK, further writedowns from HBOS and that the private-equity industry will endure massive losses. But he does not believe these things will happen.
Potter said: “The current share price implies HBOS will never again generate a return above its cost-of-capital, a situation that we feel that regulators and/or consolidators would be unlikely to allow to persist. It also implies a further £6.1bn of net losses in the bank and zero growth generation.”
While Potter attacked the apparent inability of the HBOS board to provide greater visibility about its future earnings, he said the bank was not unique in this. “There are a lot of things I dislike about this bank, but every asset has its price, and the price at which HBOS is currently trading is getting silly.”
Potter does not believe the Edinburgh bank will make a loss either in the current year or in 2009. In fact, he estimates it will make profits of £3.3bn in 2008, £4.9bn in 2009 and £5.2bn in 2010. The 2008 figure represents a fall of almost 40% from the £5.4bn actual profit made by HBOS in the year to December 2007.
Richard Barnes, analyst at Standard & Poor’s, said: ”HBOS’s profitability should remain reasonably robust due to better pricing on new lending, tight cost management and stable performances from the insurance businesses. The benefit of wider asset spreads will be offset in 2008 by higher funding costs, but should drive a stable or increasing net interest margin in 2009-2010 as more loans re-price. This is an important mitigant to the higher impairment losses that we expect in those years.”
On Thursday, Lord Stevenson lashed out at UK regulators for failing to deal with white-collar crime, including stock market manipulation followed by short selling, which is believed to be one reason that HBOS shares have sunk. However, Colin McLean, chief executive of SVM Asset Management, said Lord Stevenson was wrong to blame hedge funds for what are more intrinsic problems at the bank. He said: ”That’s a smokescreen. It’s up to the bank to reassure investors about its prospects and strategy.”