Over the past year, UK banks have incurred a significant amount of writedowns on the back of devalued sub-prime related securities. Earnings and balance sheets across the banking sector were dented and a softening economic outlook in the UK and US, coupled with fresh sub-prime news, caused selling pressure on banking shares to mount.



Of the FTSE 100 banks; HSBC, RBS, HBOS and Barclays were the worst casualties in terms of writedowns and credit losses between 2007 and 2008 according to Bloomberg. During this period HSBC incurred ?9.8 billion in writedowns and credit losses, followed by RBS with losses amounting to ?7.8 billion. During the same period, HBOS and Barclays suffered from ?3.6 billion and ?3.2 billion in credit losses and writedowns, respectively. These writedowns (which are extremely complicated to value) have contributed to elevated levels of liquidity and default risks and the primary cause for the sharp sell-off in the sector.

Although the sector has incurred a large amount of writedowns, there remains a view that further losses are in the pipeline: analysts recently stated that banks may have to continue slashing dividends and issue additional equity in order to counter further writedowns and liquidity constraints. On 26 June 2008, this view was reinforced when Belgian bank Fortis announced that it would cancel its 2008 interim dividend, issue new shares and sell non-core assets in order to revive its balance sheet. Analysts at Goldman Sachs predicted further writedowns for Citigroup, the world's largest bank. Consequently, expectations of further and possibly larger writedowns are likely to lead analysts to revise their banking sector earnings lower and this outcome will add further downward pressure on share prices.

High oil prices and a softening economic outlook have also contributed to the negative sentiment surrounding FTSE 100 stocks. Companies are shedding labour as energy costs eat into corporate profits and banks are scaling back on staff in order to prepare for potential losses and protect liquidity levels.

According to Anthony Grech of ?This has had implications on the wider economy. As UK companies shed labour, mortgage defaults rise and banks, which are already anticipating the worst, continue to tighten lending criteria. Data released in June confirms that UK bank lending, as measured by the BBA mortgage approvals, dropped at an annual pace of 56.1% in May. This vicious circle is adding to fears and weakening the outlook for the British economy further. It is also enticing investors to safer, higher yielding cash and money market instruments and probably contributing to the selling pressures across the entire equity market?

However, are we close to the bottom? Should we be like bank shares to go down or not? A recent analysis of the performance of seven FTSE 100-listed banks revealed that five out of the seven banks halved in value in just one year.

As of close on 23 June 2008, Alliance and Leicester was 74% below last year's price followed by HBOS with a 73% annual decline. Moreover, RBS's share price was 66% lower over the year while Barclays and Lloyds were down by 58% and 44% respectively. Is the sharp sell-off overdone or is it too premature to tell?

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