Alliance & Leicester, No. 7 among the British banks, abandoned earnings targets for this year because higher funding costs will hold back its profit margins.
The lender said its 2008 net interest margin (NIM) - a key sensitivity for earnings - will be about 1%, against previous guidance of 1.07%. It also discarded its EPS target, brought in place this time last year, of 9% growth above the retail price index by 2009; management claimed it was "no longer appropriate".
"We do not think this will be the end of the story and think the wholesale markets are unlikely to function at economic levels for UK mortgage banks in the medium term," said analysts at JP Morgan. "This has a negative read-across for the other UK banks as well."
In all, A&L failed to achieve any of the five performance targets it set last year. Return on equity, for example, totaled just 14.6% compared with a 20% target
The biggest surprise was that A&L held its final dividend flat at 36.5p, against consensus expectations of a 4% hike. Managment said it expects to hold the dividend again in 2008, versus forecasts of 5% improvement.
"We believe this reflects the difficult environment with guidance for core operating profit (excluding write-downs) to be lower in 2008," Citigroup analyst Rohith Chandra-Rajan said in a research note. "Additional funding lines costing an estimated £150m per annum and a shrinking mortgage book will be only partially offset by expected growth in commercial loans."
A&L reported an annual profit of £399m, fallling from £569m in 2006 and below an average forecast of £416m. However, the headline numbers included Treasury write-downs of £185m and an impairment charge of £147m, which were flagged up in a trading statement late last month but not included in all market forecasts.
The bank valued its trading and investment portfolio is at £15.53bn at the end of last year, including £4.1bn in asset-backed securities (ABS), £298m of collateralized debt and loan obligations (CDO/CLO) and £213m in structured investment vehicles (SIV). There was no comment on whether the quality of these investments had deteriorated further since the year end.
A&L said its loan balances fell £600m in the final quarter of 2007. The company assured that it has has raised sufficient funding for its refinancing needs this year, but gave no specifics on the costs involved other than saying that "the facilities, which typically last around two years, cost more than would have been the case in the first half of 2007."
It also warned that loans outstanding are expected to fall in 2008, as a shrinking mortgage and unsecured lending book is partially offset by some growth in commercial lending.
JP Morgan repeated an "underweight" rating.
"The results for 2007 look average, given a low expectation level and quite specific guidance. Nevertheless, the outlook remains grim and management seem to have accepted this to some extent," it told clients.
"We remain comfortable with our recommendation on a fundamental basis, however the more grim things look the more likely it is that the board may feel more pressure to seek the safety of a strategic partner. The key question is how low the stock will be by then. Despite recent underperformance, (-27% in the last month) the stock should continue to underperform."
Cazenove's Simon Pilkington kept "outperform" advice, saying the funding problems are probably not long term.
"The cost of securing additional liquidity has proved higher than expected, aggravated by the persistently high level of Libor," he argued. "We do not believe that the current funding cost can persist and therefore some element of the reduction in earnings is temporary, if lasting through 2009.
"With dividend cover low and continuing uncertainty on the outlook for additional Treasury impairment, there will be little support to the valuation from the dividend.Longer term we expect the multiple will expand to reflect the potential NIM recovery and the re-emergence of bid speculation."
Shares in A&L as much as 19% to trade at their lowest since flotation in 1997, then rallied to a 14% decline at 452.25p by midmorning as short-sellrs closed positions.
The stock was trading as high as 782p in January, before Spanish peer Santander denied it was interested in making a bid. About a fifth of the stock has been loaned out by traders betting on further declines, according to recent filings.
