What does financial meltdown mean?

Published on Friday 19 September 2008 21:52

AS IF the demise of Lehman Brothers wasn't enough to digest, the merger between Lloyds TSB and HBOS has direct implications for almost every other household in the UK.

Between them, Lloyds TSB and HBOS account for nearly a third of the UK mortgage market, have 3,000 high street branches and over 325 billion in savings.

So here are the answers to some of the many questions posed by this week's events.

Q Is my bank safe?

A If anything, this week (as with Northern Rock a year ago) has demonstrated that the government has no appetite for letting a major British financial institution fail.

Banking shares plummeted following the collapse of Lehman Brothers, although the proposed Lloyds TSB and HBOS merger ended any uncertainty over the future of the latter.

The Treasury continues to work closely with the UK's biggest banks in establishing the extent of their reserves and the Chancellor, Alastair Darling, has pledged that the rules governing the UK banking system will be tightened.

Q Is my local branch likely to close?

A There's a chance it will. Between them, Lloyds TSB and HBOS have 3,000 branches and many of them are on the same high street. It's inevitable that some will close and Lloyds TSB has already said it will eliminate branch duplication. At this stage it's estimated that up to 1,000 branches could go.

Q What about my savings?

A The merger, which will take several months to complete in any case, is no threat to any savings you have with either HBOS or Lloyds TSB.

If you have savings with both, the FSCS will now cover you for a maximum of just 35,000 between the two rather than 35,000 each, unless the banks choose to remain separately authorised (like RBS and NatWest). If you already have more than 35,000 with one brand it would be wise to move some of it elsewhere.

For savers, the broader crisis could have a short-term payoff as lenders improve savings rates to bolster their deposits.

In the long term, the reduced competition resulting from the HBOS-Lloyds TSB deal could be bad news for savers, however.

And with inflation reaching 4.7 per cent this week, an interest rate cut by the Bank of England next month is a strong possibility and savings rates could drop off accordingly.

Q How is the mortgage market affected?

A Banks are again nervous about lending to each other and the cost of lending between banks has risen. Mortgage rates resumed their upward path yesterday, after two months of gradual falls, with one lender hiking the cost of its deals by up to 1.6 per cent.

Rates on longer-term fixed rates have already started rising and increases will also feed through to the more popular two and three-year deals.

If you have a mortgage with either Lloyds TSB or HBOS, your deal won't change. But the combined HBOS and Lloyds mortgage book accounts for nearly a third of the UK market and features six big mortgage brands – Halifax, Bank of Scotland, BM Solutions, Intelligent Finance, Lloyds and Cheltenham & Gloucester – and as some of these disappear (as many predict) competition and consumer choice will be reduced.

In addition, Lloyds TSB is famously conservative so the new bank is likely to steer clear of the higher-risk end of the mortgage market. Consequently, those without a big deposit, or with a tainted credit record, could find it harder to get a mortgage from the merged entity.

However, if the Bank of England does cut interest rates next month, those with variable rate mortgages (such as trackers) should see costs fall.

Q How are my pension investments affected?

A Most people now have a pension in which the fund is stockmarket-based and its value will be lower after this week's global markets sell-off. Only those close to retirement lose out directly as markets will recover their value over the longer term, as yesterday's bounce suggested.

If you're approaching retirement, your exposure to the stock market should be limited or non-existent, as most of your money should be in more secure assets including fixed-interest and cash.

If you haven't derisked your pension portfolio and you're close to retiring, it could be worth deferring retirement rather than accepting a lower income in retirement. Historical evidence shows that, over time, volatile periods such as this are levelled out. However, the deficits incurred by companies in the downturn could lead to more schemes being closed to new members and future accrual. If a firm in which you invest goes bust, the Financial Services Compensation Scheme (FSCS) can pay out up to 48,000 in compensation.

Q How do I go about reviewing my pension investments?

A If you want to check how your investments are affected by market turmoil, websites including www.trustnet.com and www.iii.co.uk carry up-to-date pension and investment fund performance figures. Alternatively, you can get fund performance data from your pension provider's website or contact your provider directly.

If you want to switch some investments, take time to consider the decision in terms of your risk appetite, your objectives and your overall financial situation and factor in the costs that any switches may incur. In other words, do you homework before reacting - short-term volatility is part and parcel of equity-based investing and is typically smoothed out over the longer term. If possible, speak to an IFA for guidance.

Q What happens to my HBOS shares?

A Under the deal terms, HBOS shareholders will get 0.83 Lloyds TSB shares for every one HBOS share, which values the latter at around 2.19.

The final dividend for the current financial year will be paid in shares and HBOS shareholders will still get a say on the merger, which must be approved by a majority of both banks' shareholders.