Bradford & Bingley: the sleepwalk towards the abyss

The bank bought US mortgages when everyone else was running away. It refused to sell a stake and then relented. It denied it needed a rights issue and then announced one anyway. What now? asks Simon Evans
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Nearly three months ago, when the rumour mill was in overdrive amid talk of pending rights issues, a delegation of executives from the American buyout group TPG met with Bradford & Bingley's bosses, chief executive Steven Crawshaw and Chris Willford, the finance director.

The introduction over dinner, arranged by investment bank Goldman Sachs, led to TPG's co-head, Philippe Costeletos, tentatively mooting his group take a stake in Britain's biggest buy-to-let bank.

The deal would enable the financially hamstrung B&B to recapitalise its balance sheet and avoid a rights issue, offering a face-saving way out for senior management.

Crawshaw and Willford weren't interested, politely declining the advance and instead choosing to plough on.

Just weeks later, reports surfaced that events had turned further against B&B with a deterioration in global financial markets, forcing the bank to contemplate a rights issue.

The suggestions were vigorously denied, both by Crawshaw and his spin doctors at PR firm Finsbury.

But just three weeks ago Crawshaw was forced to admit he'd got it wrong and would, after all, be tapping his shareholders for £300m to shore up the bank's worsening finances.

And last week, the latest act in the tale was played out. First Crawshaw said he was stepping down as chief executive citing ill health. Then, just two days later, Kent revealed that the terms of the rights issue had been watered down amid fears the markets would give the original offer a thumbs-down.

Investors would now be offered rights at 55p a share rather than the 82p first announced. Just one year ago, B&B shares were trading at over 400p each.

And the final ignominy: TPG, led by the no-nonsense David Bonderman (see facing page), would be taking a 23 per cent stake in the company at a deeply discounted 55p, costing the US group £179m – a near 50 per cent discount to book value.

The positions of long-suffering small shareholders would be diluted further, while Kent also dangled the increasingly likely prospect of the dividend being scrapped too.

Shares in B&B shed a quarter of their value in a day. Analysts predicted that much worse was to come.

So far, the group has had to write off more than £130m in assets that have deteriorated in quality during the credit crunch. A further £89m loss was revealed last week. Analysts expect pre-tax profits to halve this year compared to 2007, and there are no signs of a let-up in the soaring cost of wholesale borrowing.

And B&B has another potential disaster looming. Last September, when the first effects of the credit crunch were being felt and most people were running the other way, B&B entered into a £1.1bn deal with US finance giant GMAC to buy a portfolio of mortgages when most people were running the other way. The commitment to buy another £2.1bn worth of assets in this contrarian play looks set to cause further woes, with analysts describing delinquency rates at GMAC as "startling".

In the wake of last week's volte face at B&B, a number of revelations have surfaced about the group's handling of the credit crisis. Not least is the reporting system used by the firm to ass-ess its financial strength. We learnt that internal profit figures were generated 31 days in arr-ears. Even Northern Rock got its numbers together quicker.

According to Alex Potter, an analyst at Collins Stewart, this revelation means any management guidance will hold little credence with investors in the future. "B&B's ability to generate its own historic numbers appears to be weak, let alone its ability to forecast efficiently."

Kent seemed to agree, admitting last week: "The bank is slow at producing management information."

Kent has been at the helm of the group as chairman for over five years. Oxford-educated, he made his reputation hauling blue-blooded City investment house Close Brothers back from the brink. Former colleagues at the bank describe him "as a man of detail", while others have been less kind, suggesting his "old- school-tie ways" leave him ill-equipped to preside over the rescue of B&B. Bets are already being placed as to how long he'll stay at the bank.

The saga also casts a shadow over the role played by B&B's highly paid band of non-executives directors – appointed, of course, to keep a watchful eye on what management was up to.

The group's annual report shows that it spent a few thousand pounds shy of £600,000 on non-executives last year. Few shareholders will deem that to have been value for money.

The cosy fireside chats that many believe constituted the dialogue between non-executives at the firm are likely to disappear when TPG appoints a number of its own men to the board in the coming weeks.

The reputation of B&B's banking advisers has also been tarnished. When companies seek cash through rights issues, City regulators say that deals should be fully underwritten – in other words, that banks stump up the cash to buy any unsold rights. They are, of course, paid handsomely for this.

But, it seems, not handsomely enough. Both Citigroup and UBS are thought to have lobbied B&B bosses to further discount the price at which it was offering rights to shareholders, fearing they would be left with a rump of rights if changes weren't made.

The banks are believed to have had their legal teams scour the fine print of their agreements with B&B, searching for force majeure or material adverse changes that would trigger clauses and let them off the hook.

Nobody knows the extent to which the pair passed on their risk to other banks and institutions through sub-underwriting, but their collective nervousness would suggest not much.

Both Citigroup and UBS have refuted suggestions they were looking to extricate themselves from underwriting obligations.

The Midland Hotel in the centre of Bradford will be the setting for B&B's extraordinary general meeting next Monday, when shareholders vote on the terms of the rights issue and whether to approve TPG's arrival.

But the intervening seven days are likely to bring a flurry of activity. Data Explorers, a firm that monitors stock borrowing linked to short-selling, says hedge funds are continuing to bet that B&B stock will fall. More than 16 per cent of the company's shares are now being lent out and, probably, shorted.

Indeed, it is an issue that has come to the attention of City watchdog the Financial Services Authority, which is investigating shorting activity prior to last week's profits warning.

The influential Treasury Select Committee is also likely to scrutinise events.

"Rights issues just don't fail," says a banker linked to the deal. "I can think of a handful in my time that haven't gone through."

In the days ahead, we'll find out whether they do. The mess B&B's management has created for its shareholders could soon get a whole lot worse.