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HBOS Shares Get Hit as Mortgage Margins Fall

HBOS, Britain's biggest mortgage lender, said higher funding costs hit its margins last year and both financial and housing markets were set to stay tough, eclipsing a slim rise in profits and hammering its stock.

The bank also said on Wednesday that it would take a 227 million pound ($446 million) hit from the value of risky assets tarnished by financial market turmoil.

That is up from guidance of 180 million pounds through to the end of November, but below the level of most of its rivals.

Underlying pretax profit was 5.71 billion pounds for 2007, up 3 percent from 2006 but just below an average forecast of 5.73 billion from analysts polled by Reuters Estimates.

HBOS said its net interest margin fell to 1.63 percent for the year from 1.72 percent, as its retail banking margin dropped 12 basis points to 1.66 percent due to competitive pressure in the first half and higher funding costs in the second half.

The margin pressure dragged retail profits down 13 percent from 2006 to just over 2 billion pounds, and helped send the bank's shares down 6.8 percent to 657 pence, by far the weakest stock in the FTSE-100.

"The negative reaction is based around the margin and outlook statement, but the actual performance is in line," said Exane BNP analyst Ian Gordon. "Clearly margin deterioration continues while the funding conditions remain as they are, but I don't think that is new news."

Corporate banking margins also dropped by 19 basis points and bad debts in the unit jumped 40 percent to 602 million pounds, adding to the pressure on shares.

Analysts said there was also a threat of more writedowns as the bank holds 41.9 billion pounds of asset-backed securities in its Treasury assets.

HBOS's profits were also swelled by 1 billion pounds from the realization of assets in the bank's corporate investment portfolio, more than double the 2006 total.

Analysts had expected the big rise, but said that income is likely to drop sharply this year, even though the book value of the investment portfolio rose 54 percent to 4 billion pounds.

The corporate unit's profit rose 31 percent to 2.32 billion.

Margins to Stabilize

HBOS Chief Executive Andy Hornby said margins will be "far more stable" in 2008. He said "relatively stable" indicates a move of plus/minus 4 basis points, but declined specifically to forecast this year's likely margin move.

"We're quietly confident that prices have moved forward and as the year moves on margins will be far more stable in our retail business," Hornby told Reuters in an interview.

Hornby said there had been no change to guidance from last year that funding costs were between 150 million and 180 million pounds higher on an annualized basis, but said a "good proportion" of that was now being recovered from higher prices.

"There will come a time when wholesale funding costs start to ease back, it may be late 2008 or early 2009, but at that stage you'll see a really resilient margin performance as underlying pricing is relatively attractive at the moment," he said.

HBOS said it expected market conditions to remain uncertain this year, but that over the past five months mortgage prices had adjusted to take account of higher funding costs.

Hornby predicted Britain's net mortgage market will grow by between 80 billion and 90 billion pounds in 2008, less than in recent years, and for HBOS to continue to write around 20 percent of gross lending, near its traditional share.

"It's not a housing market that's gone into free fall, it's still showing good growth but lower growth," Hornby said.

The bank's share of net lending recovered to 22 percent in the second half of last year, after slumping to 8 percent in the previous six months, for a full-year outturn of 15 percent.

Cost growth this year will not be higher than the 7 percent growth seen in recent years, and "will probably be lower," Hornby said.

The bank will continue to invest in its international expansion, notably in Australia, he said. International profits rose 23 percent to 757 million pounds.

The bank proposed a 2007 dividend of 48.9 pence a share, up 18 percent and ahead of analysts' forecasts for 47.4p.