Lloyds will discover HBoS’s hidden US problem
The question was not whether HBoS was too big to fail but whether it might be too big to save? The problem is not its exposure to the UK housing market but its exposure to US mortgages. Lloyds TSB must avoid being contaminated by HBoS’s problems.
The fate of the HBoS matters not only to the 15m people who have entrusted Halifax with their savings but to those who have borrowed it back to buy their homes and the many companies wooed by Bank of Scotland’s business banking. HBoS’s fate matters.
When it was trying to raise £4bn from shareholders to shore up its balance sheet HBoS blamed hedge funds and short-sellers. The bears were right however: the shares have carried on falling to stand 80 per cent down on the year and the rights issue was shunned by almost all shareholders.
Lehman Brothers’ demise acted as a reminder that big banks can fail but the subsequent cut in HBoS’s credit ratings is merely a reflection of the truth.
The core problem is not HBoS’s UK mortgage lending – though the third of its book on loan-to-value ratios of 80 per cent or more will be in negative equity as soon as house prices fall 20 per cent (and they’ll fall more than that). Nor is it the bank’s extensive lending on commercial property or its private-equity backing of property-based businesses such as housebuilding and carehomes.
Those will make their dent, but it is the US mortgage-backed residential securities that are the potential killer. The good news is HBoS has only a £105m exposure to sub-prime bonds; the bad news is the £6.6bn of “alt-a” securities – bonds that until now have been considered not-quite-prime but are really more sub than prime.
Alt-a debt is allegedly as good as prime but did not quite meet the qualifications required. That was often because the lenders didn’t know who they were lending to or against what security. Such little documentation was required alt-a loans were nicknamed “Liars’ loans”.
HBoS concedes the market value of its alt-a loans is not £6.6bn but has not taken the hit against its profits. If it did, the capital raised in its rights issue would disappear.
Compared with that problem, HBoS funding gap is insignificant.
HBoS will be a mouthful for Lloyds TSB, but its rescuer has a low exposure to US mortgages. It must be careful not to let HBoS’s problems overwhelm its own balance sheet but when banking recovers, Lloyds will have made an expansion that would never normally have been permitted by the competition authorities.
For Lloyds TSB, it is not a bad consolation prize for failing to rescue Northern Rock?
