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WSJ: Rate Cut May Not Be the Answer To Fall in U.K. Mortgage Values

November 26, 2007

October was a bad month in the U.K. mortgage business. The value of mortgages approved was 27% lower than the average over the previous six months, according to the British Bankers' Association. It looks like the credit crunch is hitting home, literally.

The decline in October approval values was especially severe -- down 19% from September -- but it only confirmed the bad news of the previous two months. As recently as July, the value of approved mortgages was only 3% below the average of the previous six months. That gentle pace of decline began last December. But in August and September the value of approvals was 11% and 13%, respectively, below the six-month average.

Northern Rock's travails probably explain some of the sharp falloff. The mortgage lender was pulling back even before it hit the headlines in mid-September. In any industry, the disappearance of a participant with a 20% market share is disruptive.

But the Rock's competitors aren't taking up the slack. The reluctance is hardly surprising. With funding scarce and expensive, U.K. banks are anxious to keep their balance sheets from growing. The mortgage securitization business, which was just taking off in the U.K., has dried up. So mortgage loans have also become more scarce and expensive.

The volume declines haven't yet translated into house prices. The various indexes show prices have flattened, but not fallen. Declines will be hard to avoid, however, if credit stays tight.

In turn, falling house prices could create a small army of distressed, soon-to-be dispossessed, homeowners. That would be an unsatisfactory outcome for the Bank of England, which cut the overnight interest rate in August 2005 at the earliest signs of house-price pressure. The market is counting on a rate cut by early 2008.

But lower rates might not work as well this time as last, when house prices immediately resumed their vertiginous rise. As the U.S. is learning, in a credit squeeze, low rates aren't always enough to keep borrowers out of trouble.

Sanofi-Aventis

It's lonely at the top these days for Gerard Le Fur, chief executive of Sanofi-Aventis. The French pharmaceutical group has lost a quarter of its market capitalization over the past two years. It faces a class-action lawsuit in the U.S. over an anti-obesity drug. Patents will soon expire on some of its blockbuster products, and its pipeline of new drugs fails to impress.

To top it all, both of the company's biggest shareholders, oil company Total and L'Oreal, the cosmetics empire, want out. L'Oreal showed the way earlier this month by selling 1.8% of its holding, leaving it with 8.7%. Total says that the time has come to dispose of its 13% stake, but that it wants to do it in an orderly manner.

Sanofi-Aventis now faces the prospect of a scattered shareholder base and poorly performing shares. Since the company was formed in 2004 from the merger of Sanofi and Aventis, its stock has underperformed a weak sector. It trades at a 30% discount to those of its bigger Swiss rival Novartis, based on expected 2008 earnings.

Cheap shares with no controlling shareholder sounds like an invitation for a takeover bid. But it is unlikely that Sanofi will be taken over any time soon, for at least two reasons. The first is its mere size -- with an enterprise value of €85 billion ($126 billion), the French group would be quite a mouthful even for bigger companies like Novartis, GlaxoSmithKline or Pfizer.

The second obstacle is French politics. In 2004, Nicolas Sarkozy, who was finance minister then, drove the merger with Aventis to put pressure on Novartis, which wanted to take over Aventis. President Sarkozy would probably do whatever it takes to prevent a foreign company taking over his cherished "national champion." No price is too high for Gallic pride -- certainly not the suffering of shareholders.

Kelda Buyout

Despite the credit crunch, the infrastructure market is still hot -- at least, judging by the offer for Kelda, the U.K. water group. Citigroup and HSBC's proposed £3 billion ($6.18 billion) bid values Kelda at a 29% premium to its regulated asset base (RAB) -- a higher multiple than J.P. Morgan paid for Southern Water last month. Investors in the U.K.'s four remaining listed water groups will be licking their lips.

The premiums offered for both Kelda and Southern are similar to the prices paid for Thames Water and Anglian Water by Macquarie and 3i, respectively, earlier this year. That indicates the $150 billion wall of money raised by infrastructure funds in 2006 has been undeterred by the credit crunch and is still looking for secure, regulated income streams available from water companies.

The offered price isn't cheap. The listed U.K. water sector trades at an average premium of 13% to RAB. And the average price increases Kelda is allowed to introduce before 2010 is below two of its four listed peers. It is also very likely that the regulator's allowed increases for the next regulatory period, 2010-2015, will be less generous.

What the consortium gets for its money, apart from a home for its funds, is what is regarded by many analysts as the best-run U.K. water utility. Kelda has topped industry performance charts for two of the past three years. The full price also makes it less likely that rivals will be tempted into a bid.

If the bid is accepted, attention will turn to the U.K.'s four remaining listed water companies. Applying the same premium Kelda is being offered to the share prices of Northumbrian Water, Pennon, Severn Trent and United Utilities would grant upsides of around 20% for each. Their shareholders may now be hoping for a swig of the good stuff.

--Edward Hadas, Pierre Briançon, George Hay

• This column is written by breakingviews.com, an online financial commentary site.


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