HBOS shocks market by missing margin and return-on-equity targets

HBOS, the UK's fourth-largest bank, yesterday warned shareholders that rising interest rates would hit its profit margins this year, as well as its share of the mortgage market.

In a trading statement yesterday, the bank said its share of the UK mortgage market would fall to below 20 per cent this year after becoming stricter on its lending criteria. In the face of rising interest rates, the bank has reined in the borrowing it will allow for fear of customers defaulting on debts. As a consequence of this lending prudence, it has had to turn away customers.

"As intended, our policy of gradually tightening lending criteria as rates rise is resulting in slower asset growth. In mortgages, this is expected to result in a share of net lending below 20 per cent for both the first half and the full year," James Crosby, chief executive of HBOS, said. In 2003, it controlled 25 per cent of the UK mortgage market.

Shares in the bank yesterday fell more than 2 per cent during trading, before recovering slightly, as investors showed their disappointment at revised profit targets. The bank said the impact of rising interest rates and slower growth on its mortgage book meant its target of a 20 per cent return on equity may now be difficult to hit. This target has been a central point for investors and Mr Crosby said only five months ago the bank was on track to deliver it. "Our decision to slow asset growth means we may not quite achieve our 20 per cent target," he said. The shares closed down 7p at 694.5p.

Mirroring similar recent announcements from Lloyds TSB and Alliance & Leicester, HBOS said its net interest margins - a key measure of its lending profitability - would fall this year. It is set to drop 12 basis points this year after a drop of 6 basis points to 1.77 per cent in 2003. But where Lloyds blamed this squeeze on margins on tough competition between banks to win business, HBOS said its fall was due primarily to the increased costs of borrowing in the wholesale market.

HBOS funds most of its lending from borrowing from other banks, and LIBOR, the borrowing rate in the wholesale lending market, has increased, making the cost of funding business for HBOS higher. "The crucial point is that this is not about competitive pressure," Mr Crosby said, adding that the decline in net interest margins was being offset largely by tighter cost controls and an increase in fees and other product charges.

Mr Crosby said he was comfortable with the City's consensus forecasts for profits in 2004. Pre-tax profits came in at £3.77bn last year, a rise of 23 per cent, and analysts are predicting a figure of about £4.51bn for 2004.

Sentiment towards HBOS shares has been hit by its heavy involvement in the housing market. The Bank of England has raised interest rates by a quarter of a percentage point four times since November to try to dampen consumer borrowing and spiralling house prices. Recent figures from the Council of Mortgage Lenders show gross mortgage lending is beginning to shrink.

Analysts at Teather & Greenwood said: "HBOS's statement was initially disappointing as full-year net interest margin erosion will be higher than originally guided. But margin erosion is a function of movement in interest rates rather than their quantum, so all things being equal, should wash out over time. In general terms, HBOS is making good progress across all its businesses."

HBOS said its credit quality was stable and that it was experiencing strong growth in its savings and insurance business. Its corporate banking division is also improving on last year.

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