End of windfall joyride?

By THIS IS MONEY
Updated: 19:00 EST, 30 August 1999

The windfall bandwagon is still rolling, but millions of investors are finding the ride less comfortable than expected.

The next big names to hand out free shares will be Bradford & Bingley, Scottish Widows and Canada Life. But a look at previous payouts shows there is no guarantee that the windfall winners will find themselves on the road to riches.

The banking sector hit the rocks this year and windfall share prices have slumped. Interest rate worries here and in the US have been the biggest problem. But shareholders have faced other challenges.

The former building societies, often referred to as mortgage banks, have been damaged by intense competition, says Ian Hodges, investment analyst at Barclays Stockbrokers. 'All demutualised building societies have seen their shares come off their highs and are feeling the effects of increased competition in their traditional savings and mortgage markets.

'Competitor Standard Life bank, for example, has been aggressively winning mortgage business. And the likes of Egg, the Internet arm of Prudential, and the supermarket banks have been taking savers,' he says.

'Mortgage banks responded by increasing savings rates and lowering mortgage rates, but this reduced their margins. Many now accept they will have a smaller market share and will diversify their interests.

'Many have decided not to fight for new mortgage business and instead protect their profit margins. They can afford to do this because their mortgage business is still profitable, but it may not be a good long-term strategy,' says Hodges.

Halifax has been hit hardest. This is not surprising as it is the UK's largest mortgage lender and has most to lose. Its share price has fallen sharply in recent months, but it has taken action to improve its prospects, says Jeremy Batstone, head of research at NatWest Stockbrokers.

'Halifax has worked hard to cut costs. It is also building up its non-mortgage business, and recently acquired Clerical Medical for its investment business. While it still has a lot to do, it is at least facing up to the job,' he says.

Woolwich and Northern Rock have also seen their share prices fall sharply because of heavy reliance on mortgages. Woolwich has started to diversify its activities to reduce this dependency. But Northern Rock has decided to stick to its traditional business areas and experts say that its low cost base means it can still face the new competition head-on.

Abbey National has weathered the storm better than many because it is the most diversified. But even it relies on mortgages for 50% of profits.

Alliance & Leicester is also well diversified - its other activities include the Post Office Counters business, Girobank. Its share price has not been as hard-hit as many other windfall shares because it has been under-pinned by speculation of a merger.

The banking sector is having a tough time, but over the long term it is expected to do well as demand for financial services increases. However, the more diversified a bank's activities, the more likely it is to flourish, says Hodges.

'In the long term, all former building societies except Northern Rock will want to increase their non-mortgage business, such as personal loans, fund management and insurance. They would then be in markets that are expected to have good long-term growth,' he says.

What the experts say
Barclays Stockbrokers' recommendations for the next 12 months are:

Abbey National: Sell. Shares are expensive in relation to the bank's prospects.

Alliance & Leicester: Hold. Seen as a likely merger target.

Halifax: Sell. 71% of its profits come from savings and mortgages, so it could suffer from competition.

Northern Rock: Hold. Has among the lowest costs in the mortgage sector and is well placed to take on the competition.

Woolwich: Sell. It is still reliant on its mortgage business and it will be a long time before the benefits of its non-mortgage business come through.

Norwich Union: Hold. Insurance companies are expected to do well. For those prepared to take a longer-term view, the prospects are better, says Hodges.

NatWest's recommendations for the next two years are to hold Abbey National, Alliance & Leicester, Halifax and Norwich Union.

The bank recommends adding 10% to holdings in Northern Rock because this is a potential merger target.

It suggests reducing holdings in Woolwich by a similar amount as it feels the bank lacks a coherent strategy.