British banks worry as billions go down drain in credit crunch

The crisis triggered by low-quality homebuyers on the other side of the Atlantic defaulting on their subprime mortgages has already claimed a highprofile victim here in the shape of Northern Rock. But as the UK's major banks all approach their financial yearends their share prices have collapsed on fears that they will follow their US counterparts with massive write-offs.

The banks are set to tell the market how badly they have fared when they begin issuing pre-close trading reports at the end of this month and early next.

In the States by far the biggest writeoffs have all come from the large investment banks. They were the specialists at the heart of the complex market which built up in collateralised debt obligations for asset-backed securities.

Merrill Lynch announced the largest third quarter writedown at $8.4 billion (£4 billion), which cost its chief executive Stan O'Neal his job with a reported golden farewell worth $161 million.

That was topped by Citigroup which, having announced a third-quarter writedown of $6.5 billion, upped its estimate last weekend to as much as $11 billion. Charles "Chuck" Prince, chairman and chief executive, fell on his sword.

Then this week Morgan Stanley said it will take a $3.7 billion writedown in its fourth quarter but warned that this could rise to $6 billion if all its subprime assets turn bad.

The problem is that the credit crisis is far from over. Banks and investors in banks have no way of knowing just how much some of their most risky assets types will fall in value.

The difficulty is exemplified by the wide range of analysts' forecasts for the likely total cost. Citigroup's Matt King predicts total writedowns of $64 billion among US banks and brokerages. Deutsche bank analyst Michael Mayo estimates $50 billion.

But that's peanuts compared with the estimate by Royal Bank of Scotland's chief credit strategist Bob Janjuah who said: "This credit crisis, when all is out, will see $250 billion to $500 billion of losses."

In a pun on the banks' normal valuation method for esoteric assets known as mark-to-market, which means they value them on current market prices, Janjuah said "the heat is on and it is inevitable that more players will have to revalue at least a decent portion" of assets they currently value using "mark-to-make believe".

UK bank shares have tanked since the credit crisis really began to bite in August. But the actual collateral damage to most of our High Street banks from the subprime crisis could turn out to be much less than feared.

HSBC blew the whistle on the subprime crisis way back in February. It had direct exposure to the market and closed its subprime business in September, recording a loss of $800 million. Analysts do not believe there are any more skeletons lurking in its closet.

Alliance & Leicester and Bradford & Bingley, as primarily mortgage banks, have been worst affected by Northern Rock's collapse. But their funding models are very different because far more comes from depositors than from the money markets. And their loan books, while they have an element of specialist mortgages like buy-to-let and self-certified, are far from subprime.

Lloyds TSB is the least exposed of the UK banks because of its lack of investment banking. HBOS, through its Bank of Scotland business, has a sizeable exposure to the leveraged loans market but analysts say it is more likely to report a slowing-down of business rather than a raft of bad debts.

That leaves Royal Bank of Scotland and Barclays, who for most of the year have been battling each other to buy ABN Amro.

RBS, which won that battle, could have to write down as much as £500 million according to Sanford Bernstein's Anthony Broadbent. Barclays, where Barclays Capital chief Bob Diamond has twice had to reassure the market that the investment bank continues to trade strongly, looks like taking the biggest hit. Broadbent suggests this could be as much as £1.6 billion. That would be a big chunk out of profits, which are expected to top £7 billion this year, up from £5.3 billion last year.

Nevertheless combined writedowns from RBS and Barclays of £2.1 billion seem hardly enough to justify the £28 billion that has been wiped off their combined stock market value since the start of this year.