Nobody rings a bell at the bottom of the market and it is a fool’s game to gamble on where the peaks and troughs are going to be, so we don’t.

What we do instead is determine what drove us into this crisis and monitor these drivers for any signs of a turnaround. We private investors are in no hurry and we are prepared to wait it out for as long as it takes.

As readers of the Fleet Street Daily and Fleet Street Research well know, I am bearish on banks. So why am I always talking about them? Because they are a leading indicator of the credit crunch. Banks led this crisis on the way down, and it is my belief that they will tell us when this thing is over. It is a sentiment that has been reinforced by many a market sage, including the legendary fund manager Bill Miller.

There’s a short and a long answer for why banks are so influential. The short answer: Banks represents around 15% of the total cap of the FTSE 350 making it near impossible to really take off when one sixth of the whole market is anchored by bad debt and ill will.

Over the past year, the FTSE 350 has fallen nearly 8%. Stripping out the banking sector — which has fallen 32% — that performance would be 6% higher and at all-time highs.

The long(ish) answer centres on contagion and securitisation. Still there? OK…

1. All things financial flow through banks.
2. As some of those things seize up — like borrowing rates and appetite for structured products — everything starts to fold.
3. When these things fold it starts to hurt businesses in the real world — like estate agents and mortgage lenders — which knocks sentiment and we end up in a vicious cycle.

When the blueprints and foundations are in doubt, people start jumping out of buildings and this creates a lot of casualties. That’s where we are up to now. But things are starting to change. Policy makers are making positive noises, mortgage banks are lending to borrowers and the stock market isn’t that far off its peak.

And now we have another reason to be cheerful. HBOS, one of the worst afflicted banks of the ‘crunch, surprised the market with a further signal that the end may-not-be-nigh.

HBOS goes back to ‘backed

The UK’s largest mortgage lender stunned the market by announcing that it successfully sold off £500m of mortgage-backed bonds, the first deal of its kind for any major European bank since the credit crunch struck last summer.

The mortgage-backed market has been all-but-dead recently. The method that sets prices for the complex securitised products has been called into question by academics, regulators and market traders alike. A lack of trust, transparency and appetite are part of the reason banks have been writing-down pools of mortgage-backed assets that they’ve been unable to shift.

That any bank successfully managed to create and actually sell a new product shows there is life in the old dog yet.

This is the bank’s first deal since July 2007 and may spur belief among peers that mortgage securitisation markets are somewhere to put your money once again after months of inactivity.

It’s not the first time products have been securitised — the banks have been recycling their own mortgages for a long time — but these were retained either on the bank’s balance sheet or swapped for gilts with central banks rather than offered up for public consumption.

This is the latest in a series of upbeat indications. Last month, the Bank of England launched a series of schemes to encourage trading in the market and it seems to have paid off. Spreads on top mortgage bonds fell more than 50% against government debt, which is a good thing.

The bonds are backed by a bundle of mortgages with an average Loan-To-Value (LTV) ratio of 61%. The LTV is the loan amount expressed as a percentage of the appraised value of a property… a 20% cash deposit on a property works out as an LTV of 80%, i.e. 61% is top stuff.

Seven firms bought the loans, made up of banks and insurers and the bond is set to have an average life of nearly four years. An HBOS spokesman commented that it launched the issue on the back of investor demand: “This is a welcome first step but does not mean the floodgates have opened.”

What does this all mean?

We all know that it’s premature to call the bottom. No one has the capacity to fathom the further twists and turns this tale could take. Everyone who pretended they could, and told investors to buy banks, has been dead wrong so far.

Nonetheless, if we are looking at what could be the resurgence of the structured investment market, this is a major milestone for banks:

Structured products have been dead in the water. Renewed appetite could kick-off a spate of big money deals and these divisions in the banks might start pulling their weight and start pulling in some revenue.

It also suggests that we will be seeing fewer write-downs. If there is a market to sell the assets then these losses will be wiped from the balance sheet. By extension, it could mean that bank shares could stage a comeback from their low levels as one of the drivers of the credit crunch appears to be subsiding.

It’s important to note that this is all best-case scenario speculation… that feint sound of a bell ringing in your ears could get you in trouble. It is still not time to pile into banks. When you invest in things you don’t fully understand, you and your money can easily be parted. There may be further twists and turns in the banking saga, and given the amount of opportunities in the UK market that have nothing to do with banking, I don’t know why you’d put your money there.

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The Fleet Street Letter. We warned our readers of the credit crunch before it struck and our tips have helped readers to navigate these dangerous times.

Theo Casey

Source: Banks Under The Microscope