Black horse is HBOS’s white knight

While the world's attention has been focused on the American financial sector, it's also been a momentous week in the UK one. Barclays snapped up bankrupt Lehman Brothers' US brokerage arm for a mere $1.75bn, thus beefing up its US investment banking presence. Far more significantly, a crisis of confidence in

HBOS prompted it to open emergency talks with Lloyds TSB about a takeover.

Why HBOS was vulnerable

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

HBOS came under attack early this week, with its shares at one stage down 40% on Tuesday. One problem is its exposure to the UK mortgage market as house prices continue to slump; it is the top lender, accounting for 20% of home loans. But a particular worry is that it relies on the wholesale markets for 44% of its funding. It needs to roll over £164bn of wholesale debt over the next year, and the interbank money markets have been "in a state of crisis" following the Lehman collapse, said Hugo Dixon on Breakingviews. There was a danger that confidence in HBOS would dwindle so much that wholesale lenders or depositors would withdraw their money. Once that happens, you can have "all in the way of capital and liquidity cushions you like but you are in trouble", said Jeremy Warner in The Independent.

The solution for HBOS

Given this prospect, and the fact that HBOS is too big to fail, it's no wonder the authorities encouraged the talks between HBOS and Lloyds, said Robert Peston on BBC.co.uk. Lloyds has come though the credit crunch in relatively solid shape, thanks to its "conservative approach to lending and financing its balance sheet", said Chris Hughes on FT.com. And while the combined group would control over a third of the mortgage market, competition concerns are to be set aside, given the market backdrop. This deal, said Dixon, is "the best solution for HBOS".

HBOS:165p; 12m change -80%

LLOY:280p; 12m change -46%