Market Report: Capital concerns haunt Legal & General

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The Independent Online

Legal & General recorded its fourth consecutive session in the red last night, closing at its lowest level since the mid-1990s after analysts highlighted the risk to the group's capital surplus if regulators push insurers to account for higher bond defaults.

Insurers are not usually impacted by short-term market movements in bond prices. As long-term investors, they instead make longer-term default assumptions on their bond portfolios – assumptions which in Legal & General's case look too low when compared to the wider sector, according to Deutsche Bank.

If the Financial Services Authority, the UK market regulator, pushes for higher default assumptions, L&G's IGD (insurance groups directive) surplus – a regulatory measure for calculating surplus capital – would suffer.

Adjusting the group's default assumptions to what they believe Prudential, for example, applies to its portfolio, Deutsche Bank analysts estimate that L&G's surplus would slip to £1bn, which is well below a target range of £3bn upwards.

"We estimate it would also take the solvency surplus to below the target range in the UK operating subsidiary, L&G Assurance Society. The group also has the highest sensitivity to equity market fall," they said, separately voicing concerns about the group's sensitivity to further equity market falls and its high exposure to individual and bulk-purchase annuities.

The assessment sent L&G's share price sliding to 49.5p, down 9.51 per cent or 5.2p – the lowest level since 1995.

Overall, the FTSE 100 eased 12.65 points to 4,189.59, while the FTSE 250 was 25.6 points stronger at 6,526.38.

The banking sector, buoyed in early trading by reports of a possible US government initiative to stem the rising tide of foreclosures in the troubled American housing market, buckled under the pressure of an unexpected afternoon trading update from Lloyds Banking Group, which plunged to 61.4p – down more than 32 per cent or 29.5p

The lender said its HBOS unit was set to report a full-year pre-tax loss of £10bn, unsettling traders and investors alike.

The disclosure sent shockwaves throughout the sector, depressing Royal Bank of Scotland to 21.8p, down 9.17 per cent or 2.2p, and leaving Barclays 4.29 per cent or 4.5p lower at 100.8p.

HSBC proved more resilient, giving back earlier gains to close 3.5p down at 530p.

Part of the strength was down to some supporting words from Credit Suisse, which played down the need for a rights issue, telling clients that the lender could protect its capital position by cutting the dividend.

The broker said that its stress tests – which account for variables like further writedowns on toxic assets and declining corporate revenues – indicate that HSBC was on course to end 2010 with a equity tier one ratio (ie, a capital cushion) of 4.6 per cent, which could rise to a more comfortable 5.6 per cent if the bank pays no dividend for two years.

Elsewhere, Rio Tinto recovered to 1,989p, up almost 2.58 per cent or 50p. There was much discussion about the miner's deal with Chinalco, the Chinese aluminium producer, which earlier in the week agreed to inject $19.5bn (£13.6bn) in return for the biggest shareholding and minority stakes in certain key assets.

Bernstein analysts raised their target for the stock to 2,400p from 2,000p, saying that the agreement solved funding issues for the group, which has been sold in recent months over concerns about upcoming debt repayments.

Goldman Sachs – which has put its target price under review – agreed, but added that while the proceeds of the deal should cover repayments for the next two years, "shareholders' interests in future growth from some of Rio's best assets is diluted", with the risk of further dilution if the Chinese group exercises the convertible bonds that were included in the transaction.

Kingfisher, the home improvement retail group, was 3.66 per cent or 5p ahead at 141.7p, thanks to UBS, which switched its stance on the stock to "buy".

The broker was less keen on WS Atkins, cutting the stock – which closed down 6.4 per cent or 36p at 521p – to "sell" from "neutral", telling investors that the "downgrade cycle has just started". UBS said: "Although the recent trading update said trading and cash generation for the year ended March 2009 was in line with expectations, Atkins' tone has become increasingly cautious.

"[The company] has been impacted by a slowdown in the Middle East (over 15 per cent of profits), and the UK building design businesses are facing pressures."

Tate & Lyle, down 4.3 per cent or 14.7p at 322.5p, was sent lower by Numis, which slashed its target for the sugar and sweetener group's stock to 240p from 330p.

On the upside, Pennon, the sewerage services and waste management group, swung to 448.5p, up 3.1 per cent or 13.5p, after HSBC raised its rating to "overweight" from "neutral".



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