A&L's Margin Warning, Profit Drop Hits Shares


British bank Alliance & Leicester suffered a double blow from global financial market turmoil on Wednesday, warning a big rise in funding costs would derail 2008 profit after a writedown on risky assets hit 2007's results.

A&L, Britain's seventh-biggest listed bank, surprised investors by estimating funding will cost about 150 million pounds ($292 million) more this year than under normal circumstances as it takes precautions to avoid the crisis that hit rival Northern Rock last year.

The news, alongside a 30 percent drop in 2007 profits, a gloomy outlook into 2009 and dividends put on hold sent the bank's shares down over 18 percent to a record low.

A&L suffered a 185 million pound writedown on its exposure to assets that have been tarnished by the U.S. sub-prime housing crisis -- in line with guidance three weeks ago. That cut its 2007 pretax profit to 399 million, below an average forecast of 416 million, according to Reuters Estimates.

The bank reported higher funding costs of 23 million pounds in the fourth quarter and said 2008 costs will be 150 million more than usual as it had "taken prudent measures" to increase its level of liquidity and the maturity of its wholesale funding, due to the risks of short-term balance sheet financing.

"That's come at a cost, but we feel it's the right thing to do to pay the price for security," said Chris Rhodes, the finance director who is also standing in as chief executive.

"We're now talking about a very strong funding position that takes us into Q1 2009," he told reporters, but said some of the higher costs will be repeated in 2009.

Biggest Faller

Rhodes said the bank hadn't considered tapping the Bank of England for funds: "It wasn't an option to take funding from the Bank of England because of the stigma that is attached to it."

The costs dragged A&L's net interest margin down to 0.93 percent in the fourth quarter. It now expects the margin to be about 1 percent this year, down from previous guidance of near 1.07 percent and 1.16 percent in 2007 and 1.3 percent in 2006.

"With volumes down, costs rising, margin guidance slashed, the earnings target cut and the dividend guided flat in 2008 ... the outlook is miserable, with significant earnings cuts likely," said James Hutson, an analyst at Keefe, Bruyette & Woods. "The only positive may be a white knight (bidder) if the stock falls enough."

A&L shares were down 6.8 percent at 492 pence, the biggest UK blue-chip faller, cutting the bank's value to 2 billion pounds. Shares earlier sagged as low as 428p, their lowest level since the former building society floated in 1997.

The scale of its higher funding costs hurt other UK banks, notably HBOS, whose shares dipped 2.4 percent.   

Dividend Disappointment

A&L disappointed investors by raising its 2007 dividend a lower-than-expected 2.2 percent to 55.3 pence per share and warning it wouldn't lift the payout this year. Analysts said it could be the only UK bank not to promise a higher payout.

Rhodes said the dividend cover needs to recover to at least 1.5 times earnings -- from 1.07 in 2007 and an expected 1.1 to 1.2 times for 2008 -- before it raises the payout.

"We need to get back to 1.5 to 1.7 before (we) consider increasing the dividend again," he told analysts, adding a "material deviation" from current profit guidance could force it to cut the promised payout.

A&L shares had already more than halved since May, hit by a relatively high exposure to risky assets for its size, an expected rise in funding costs and modest growth prospects as the UK housing market and economy cool.

The bank warned last month that its writedown on holdings of structured investment vehicles (SIVs) and other complex products related to U.S. subprime housing had more than tripled, and on Wednesday it said a reduction in the fair value of assets held in reserves had fallen this year by 59 million pounds. Analysts said there was the threat of more writedowns, and Exane BNP analysts estimated a further 40 million hit in 2008.

A&L executives said the industry would learn lessons from the combined hit of the sub-prime crisis and subsequent liquidity squeeze, and said its treasury would operate as "a banker rather than a profit centre" in future.

Shifts in the UK lending and savings were also being seen, and A&L said it expects to reduce mortgage lending this year and would mainly focus on existing customers. It will no longer lend more than 90 percent of a property's value to a borrower.