Yesterday mortgage lender HBOS slumped 7% as it warned that fierce competition in the mortgage market and higher funding costs had squeezed margins, and it could get worse.

A few days ago results from Barclays and Lloyds gave their share price the Viagra treatment, smashing above the downtrend line and suddenly looking a good bet for your pocket money. Alliance & Leicester dropped 14% when it announced results, but rallied 28% as Lloyds TSB hinted that it was sniffing around for acquisitions.

Banks are living in interesting times, as they say, and have been one of the most traded sectors by spread betters. I’ve had a few days where I couldn’t give a forex for the currencies, finding a good bank far more exciting.

The bank-reporting season is drawing to a close (of the UK banks only HSBC is left to report on March 3rd), leaving in its wake a lively mixture of results. And there’s something for everyone; for the pessimists Alliance & Leicester and Bradford & Bingley came up trumps with some truly awful numbers. The optimists found favour with Barclays, Lloyds TSB, Royal Bank of Scotland and Standard Chartered. And those who preferred a quiet life favoured the Irish banks, which were pretty much in line, with cautious outlooks, but no material damage from sub-prime misadventures.

A Good Poker Face
Allied Irish, Barclays, HBOS, Lloyds TSB and Royal Bank of Scotland supported their confident outlooks with generous dividend increases. But was this just a good poker face? The first bank to try this trick was the Swiss bank, Credit Suisse; on February 12th it reported a 72% fall in profits, but boasted that they’d avoided the worst excesses of the US sub-prime fall out. They were confident enough in their position to hand out a higher dividend payout and the investors fell in love with them. One week later a slightly less assured Credit Suisse announced a further £1.5 billion write down after discovering the ‘mispricing’ of some CDO products. Allied Irish, Barclays and Lloyds TSB all raised their divvy by 10%; HBOS raised theirs by 18%. Was that the ultimate bluff? The big question that Credit Suisse raises is how can we be reassured by good results when they can turn around a week after the results with another £1.5 billion write down?

A couple of banks, Alliance & Leicester and Bradford & Bingley knew when to fold. They had nothing left to bluff with.

There’s an important message here so, just in case it got lost in translation here’s a summary.
On the 1st February many people were expecting dividend cuts, big write downs and Chief Execs talking a good game. On the 28th Feb what we have from the heavyweights are dividend increases, small write downs and Chief Execs talking a good game. Even Royal Bank of Scotland, the bank with the most depleted capital base, pulled a rabbit out of its ABN Amro hat.

Chickens And Eggs
Which came first, the economic slowdown or the fall in banking profits? Put another way, are struggling economies threatening to land the banks with less business and higher bad debt provisions? Or, are the sub-prime riddled, credit-constrained banks in danger of squeezing the life out of the economy?

Firstly, looking at Ireland I struggled to find a problem, other than a red-hot housing market coming off the boil. True, it’s not been pleasant, with house prices falling 10% or more, and will lead to higher bad debt provisions for the banks. Critically however, house prices may be falling but the housing market is still liquid. As long as you can actually sell your house there is far less incentive to hand the keys back.

But check this out. GDP is forecast to fall, but from over 5% to 4%. Granted, it doesn’t put China in the shade, but that’s not a bad rate to be going on with. Household income is set to fall from 9.7% to around 7%. There hardly seems to be a pressing need for a rate cut in the Emerald Isles. Again, am I missing something?

Comments from Bank of Ireland and AIB were sensibly cautious, but both felt that business, whilst impacted by the crunchy-credit fall-out was OK (ish).

There’s a similar pattern in the UK with a slowdown in the housing market, but a lot of businesses are doing fine thank you very much. The Country still looks to be earning and spending.

Swervin Mervyn and his merry band have done their bit, cutting interest rates from 5.75% to 5.25%, despite concerns over inflation. Borrowing should have been getting cheaper, but distrust amongst the banks has meant that the LIBOR rate has started to rise again. It’s now back to 5.7%, nearly 0.5% above official rates. This, and the fact that banks have less free capital to lend, has seen an escalation of credit tightening. Most banks now refuse to grant mortgages on more than 100% of a property’s value and this week the Nationwide Building Society caused uproar by deciding to charge higher rates to anyone wanting to borrow more than 75% of the property’s value.

In simple terms, borrowers are getting screwed and it’s costing them more, even if interest rates are falling.

And talking of chickens, I’m not sure that all the scariest ones have come home to roost yet. I could be wrong, but it just feels as if the banks this side of the Atlantic (and English Channel) have been a bit more forthcoming with their exposure disclosures. The US banks still scare me; even if the New York Insurance Regulator can apply enough rolls of sticking plaster to hold the monolines in place I reckon it’ll take a while to see who owes what to whom. There’s also another silly name, devised by clever banking people, that we might need to worry about called variable interest entities. If the US banks get another dose of financial pneumonia the banks over here will start to sneeze as well.

To Buy Or Not To Buy?
Is it time to buy the banks yet? Have the cupboards been thoroughly searched for skeletons or are there some more weird acronyms about to surface that spell trouble? It would be pretty amazing if there weren’t more bad news to come. But here’s a few thoughts to stick in the blender and whirl around:

-After the sizeable write-downs of the past few months, will a few hundreds of millions in bad debts really freak us out?

-Shall I put my money in the bank or invest in the bank? Deposit rates for UK banks are around 5%. Compare that to Barclays’ shares, which have a dividend yield of over 7%, and Lloyds TSB 8%. Bank of Ireland shares yield a bit over 6%. If you want to run through what a dividend yield is check out Total Newbie Question 2. What Is A Dividend?. And whilst we’re mulling that one over, there’s a whole universe of income funds who’ll cream themselves at the thought of yields like that.

-The big boys. Lets assume that quite a few of the big boys (aka City fund managers) are smart, not all but quite a few. So the smart ones probably went underweight banks last year and haven’t found a reason to change that view yet (‘underweight is the fund management equivalent to ‘shorting’. A lot of funds aren’t allowed to hold short positions, but holding less than the benchmark, or other fund managers, is the next best thing). Once these guys are underweight the next logical step is to close that position, either to go neutral or overweight. So, there’s potentially a lot of players on the touchline looking to join in the game.

-And the foreign boys. OK, these boys aren’t short, but their money is burning holes in their pockets. I’m talking about the sovereign wealth funds (SWF) and if you’re not sure what the hell I’m talking about have a read of Funds Of Mass Destruction. This group have a long-term plan of financial world domination, and have billions of dollars to play with.

-But just before you rush for the trade button, consider this. LIBOR money rates are rising because the banks are still wary of lending to each other. If they don’t trust each other, with their intimate knowledge of the sector, why should we trust them?

What Am I Up To?
Regulars will know that I’ve been pretty active in Barclays, moving on from demo trading to trading it for real. For anyone with time on their hands here are some of the blogs:

What A Bunch Of Bankers
A Bucket Of Cold Water
Dustin For Ireland

I’ve been comfortable spread betting Barclays in either direction and at the moment, with most results out of way, I’m more inclined to buy on weakness. I might even buy on strength if I feel there’s a bit of momentum behind it. The banks’ share prices have been hit hard and I reckon that with a fair wind they’re due a bit of a bounce. Lloyds TSB follows a similar pattern on the charts, and if Tata Steel hurry up and deliver my new testicles I might be tempted by the ‘shot to pieces’, perennial takeover target Alliance & Leicester.

Happy Banking