UK banks and the curse of interesting times
James Saft is a Reuters columnist. The opinions expressed are his own.
HUNTSVILLE, Ala — It is going to be an interesting 2011 for British banks, which face funding hurdles and exposure to troubled sovereign debt and property markets.
After the carnage of 2008, the de-facto nationalizations, and the euro zone exposure scares this year, Britain’s large international banks could be forgiven for hoping at year’s end for a bit of peace.
That may not be the result, at least according to a reading of the Bank of England’s Financial Stability Report released this week.
The Bank highlighted a range of dangers, but one looms above the others: funding.
British banks have on the order of $525 to $600 billion of wholesale debt maturing in the coming year, according to the Bank of England, money that must either be refinanced or obtained by cutting back on lending or selling assets.
Partly because their size is so out of proportion to the economy which serves as their host, British banks are heavily reliant on loans, wholesale funds, and short term deposits which are far more likely to take fright and run when threats to stability arise.
The largest looming threat is the bailout or otherwise of the weak euro zone “peripheral” countries, to which the big UK banks are substantially exposed. While British bank funding costs have not been tracking the fortunes or Greece or Ireland closely in recent weeks, there is no logical reason this should persist.
Large British banks are not, as a rule, heavily exposed to the sovereign debt of the weak euro zone countries, but are, in many cases, up to their elbows in mortgage and other types of loans.
Median total exposure to Ireland among the five large banks — Barclays, HSBC, Lloyds, Nationwide Building Society and RBS — was equal to about 45 percent of their Tier 1 Capital, that bit of the banks’ balance sheets that would have to absorb losses. For Spain median total exposure was a bit more than 20 percent of Tier 1 Capital.
That means that should things turn really awful, or more to the point, should the EU waver in its apparent resolve to bail out banks rather than taxpayers, the wholesale markets could easily turn very hostile for British banks needing a hand. Of particular concern, according to the BOE, are money market funds, which are an important source of short-term funds. Money funds took embarrassing losses in 2008 and may well bolt under pressure.
TROUBLE BACK HOME?
Regardless of the funding market, the crumbling Irish economy is already hitting UK banks badly. Lloyds Bank, which is 41 percent owned by the UK following a bailout, last week made a $4.6 billion provision against its deteriorating book of Irish loans, meaning that more than half of its $42 billion exposure to the Irish private sector is now impaired.
Lloyds shares fell sharply on the news, as did those of RBS, its ward-of-the-state peer, as investors reasoned that it too would face increasing writdowns as Irish GDP shrinks under an austerity plan.
The irony, of course, is that Ireland is doing particularly badly in part because it is starving itself in order that no bank senior creditor might take a loss on exposure to Irish banks. Should losses elsewhere in Ireland, Greece or Spain bring down these very same banks in the end the irony will be complete.
Exposure closer to home may prove just as daunting. Thus far the British property market has remained miraculously resilient, despite its still high cost and the high debt burden of the typical British household. This has been a tremendous boon to the banks, with losses on secured lending — mostly mortgages — accounting for less than five percent of total losses in the nine months of 2010.
That may change, however, as British households take a hit from their own version of government austerity, plans that entail deep budget cuts and will eliminate nearly a half a million jobs.
Even before this, however, there is a chill spreading over the British property market, with mortgage approvals stagnating and prices now falling. Prices of houses fell 0.7 percent in November, according to a survey by Halifax, leaving them just 2.8 percent below their January peak.
While British banks can generally pursue borrowers other assets if they default, unlike in much of the U.S., that as a mitigating factor will only last so long as unemployment remains at manageable levels. If unemployment rises sharply, so will defaults.
It is not too hard to construct a scenario in which international capital makes things very difficult for British banks before the next year is out. If so, the BOE will likely step in and provide support.
Support they may, but depending on the kindness of central banks is, both for banks and their investors, a risky strategy.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)