Bradford & Bingley upbeat but writedowns worry rating agencies

As banks report losses on their asset portfolios, concern from raters continues. Yet despite reports of an increase in mortgage arrears, B&B remains confident, especially in the buy-to-let market

UK banks began revealing their end-of-year results last month, with Bradford & Bingley's sizeable writedowns bringing fresh fears over the stability of the sector.

Bradford & Bingley (B&B) posted writedowns of £225.6 million, halving its pre-tax profits to £126 million. These include treasury asset impairments of £94.4 million, a loss on sale of commercial and housing association portfolios of £58 million, hedge ineffectiveness of £23.5 million and other fair-value movements on treasury instruments of £49.7 million.

At first the lender seemed to blame new accountancy rules for part of the writedowns. In its results report, it said the accounting treatment of synthetic collateralised debt obligations (CDOs), of which it has £250 million invested, "differs from that of our other CDOs, despite being cash investment instruments". This means a derivative is separated from the host CDO with the derivative element subject to fair value accounting, said B&B, with any movement in value being recorded in the income statement. The bank said that, in the current environment, the separated derivatives' market price has fallen significantly, which has adversely affected current value by £49.7 million. However, B&B later stressed it was not blaming its auditor, KPMG, over advice on how to account for the fall in the value of CDOs, while clarifying that no accountancy rule changes had taken place for synthetic CDOs.

B&B also revealed that £64.2 million of its structured investment vehicles (Sivs) and £30.2 million of CDOs are impaired.

But it is the increase in mortgage arrears and possessions that shows UK banks are starting to be hit by a slowdown in the housing market. Total cases three months or more in arrears and in possession increased to 6,170 for B&B in 2007 (versus 4,337 in 2006), equating to 1.63% (1.30% in 2006) of the total book. Within this, properties in possession as a proportion of total loans were 0.15% (0.10% in 2006). With fears that the buy-to-let market - in which B&B is a heavy participant - is also slowing, times remain tough for the UK mortgage market.

But B&B is more optimistic. Group chief executive Steven Crawshaw said: "We believe the fundamentals that drive our specialist markets remain strong, and expect the buy-to-let market to continue to grow at a faster rate than the mainstream mortgage market. With significant funding in place and our savings business continuing to attract new money, we are confident of our ability to continue to be a leading player in the specialist lending market."

However, despite agreeing £2 billion of committed funding facilities with key relationship banks, which pre-fund maturing term financing into 2009, and an additional £1.2 billion of retail savings deposits already raised in 2008, B&B is still of concern to rating agencies. And with other banks securing less funding than B&B, further negative rating actions could follow.

Standard & Poor's placed its A-1 short-term rating on B&B on credit watch last month. This follows B&B's results and reflects S&P's view that the combination of rising impairments, potential margin pressure and further markdowns, and continued challenging funding conditions might not be consistent with the current rating. S&P's credit analyst Nick Hill said B&B's liquidity position, although sound, was not as strong as expected after the sale of the various loan books. "The £4 billion proceeds from the commercial mortgage and housing association portfolios did not provide the liquidity benefit that we had expected. If the rating on B&B were to be lowered, it would be unlikely to be by more than one notch," he said.

Alliance & Leicester (A&L), which the agencies have also been scrutinising lately, revealed its 2007 results last month. Impairment of treasury investments totalled £165 million and A&L incurred an impairment loss charge of £142 million relating to its Siv, mezzanine and capital note holdings. An impairment loss charge of £11 million was incurred relating to CDOs. The lender has announced a voluntary redundancy scheme, affecting 200 to 300 staff.

Like B&B, A&L's funding strategy is to increase its deposit base significantly, while reducing loan growth in 2008. A&L's total customer deposit balances increased by £1.2 billion in 2007, to £30.8 billion. "We are targeting growth in both personal and commercial customer deposit balances, with our personal and business banking current account products a key source for acquiring new customer balances," said Chris Rhodes, group finance director at A&L (see also feature, page 36).

Dippy Singh.