Market Report: Exane confidence in merger boosts HBOS

HBOS led a banking sector rally yesterday after Exane BNP Paribas said that, contrary to the bearish views held by some, the lender's impending combination with Lloyds TSB may provide a healthy upside for investors.

Although the outlook for the combined group remains uncertain, the risks are already priced in, Exane said, highlighting the around 40 per cent collapse in Lloyds' share price since October.

"As such, we now recommend a preference for Lloyds Banking Group relative to our European Banks benchmark. We have very high conviction that Lloyds will meet or exceed our forecast of £1.8bn per annum [in] synergies by 2011 and this provides a very material offset to the two banks' exposure to the impact of UK recessionary impairments."

The broker suggests that the new Lloyds could be worth 210p. Last night, after gaining 2.41 per cent, or 3.1p, Lloyds closed at 131.5p while HBOS jumped by 7.84 per cent, or 5.8p, to 79.8p.

Along with the wider sector, the two were also supported by chatter that the Government was mulling the creation of so-called "bad bank" to take on toxic mortgage back assets.

Cazenove, which maintains an "underperform" rating on Lloyds, said it felt that the "turning point for the group" rests on further intervention from the Government, "hopefully in the form of a loan guarantee framework which may in turn be a precursor to forming a 'bad bank'".

Overall, the FTSE 100 fell to 4,458.54, down 56.83 points, while the FTSE 250 retreated by 38.37 points to 6,653.88. The market moved up slightly after an official report revealed that the US economy shed 524,000 jobs in December, compared to the 525,000 predicted by analysts.

But the strength was short lived as it dawned that, despite the slightly better than expected decline last month, the world's largest economy had still ramped up its biggest number of job losses since 1945 over the past 12 months.

On the FTSE 100, the mining sector proved the biggest drag.

Anglo American was the weakest among the blue chips, losing 8.19 per cent, or 133p, to 1490p after Merrill Lynch moved the stock to "underperform" from "buy", arguing that the group's earnings were under significant pressure given the current sport commodity prices.

"At the results on 20 February we do not rule out a dividend cut," the broker said, scaling back its target price for AAL to 1, 300p from 2,050p.

Elsewhere in the commodities space, the oil group BP retreated to 519p, down 2.44 per cent, or 13p, on concern about the crude price outlook and its impact on earnings.

The fears overshadowed renewed chatter about a bid from ExxonMobil, the American oil and gas giant. The rumours, which also suggested the possibility of a bid for BG, down 1.5 per cent, or 15p, at 986p, drew strength from a new Bernstein Research report, which said that "2009 could be ExxonMobil's year".

"It has enough financial fire power to undertake large scale acquisitions," Bernstein analyst Neil McMahon said. "Such a scenario could be on the game-changing scale last seen with the wave of mergers in the later 1990s, when the low oil price also put a lot of oil companies under duress."

On the second tier, some short sellers were said to be scrambling to abandon their downside bets in Yell, which surged to 53.75p, up 11.98 per cent, or 5.75p, after Goldman issued a "buy" note.

"In our view, consensus had incorporated a negative outlook and the stock is now at a significant discount to the market and also its European counterparts," the broker said, adding that while the stock was at risk if credit conditions worsen, given the renegotiation of covenants, it saw no material short-term funding issues at the directories group. Commercial property companies traded down again, with Shaftesbury, which was the subject of a UBS "sell" note on the day before, losing 5.43 per cent, or 19.5p, to 339.75p after Citigroup also advised clients to move out of the stock on account of its current valuation.

Among smaller companies, Lloyd's insurer Advent Capital Holdings slumped after saying that it had increased its estimated losses for Hurricane Ike to £42m before tax from the £15m before tax reported in its third quarter results.

News of the looses, which are calculated net of reinsurance recoveries and re-instatement premiums, sent the stock sliding to 135p, down 20.59 per cent, or 35p.