Jeremy Warner's Outlook: When the underwriting contract is worth no more than a B&B buy-to-let mortgage

It was reasonable to assume that the men in the bowler hats knew what they were doing. Plainly they did not

When is a deeply discounted, fully underwritten rights issue neither deeply discounted nor underwritten? Bradford & Bingley's handling of its rights issue has been so calamitous that the company seems more deserving of pity than scorn. B&B appears to be in a state of almost total disarray.

It is hardly surprising that the chief executive, Steve Crawshaw, has retired hurt. If he hadn't been overcome by "a serious cardio-vascular problem", he'd certainly have been fired. Illness got there before the executioner.

Just six weeks ago, the beleaguered mortgage lender vehemently denied apparently well-informed reports of a rights issue. Then, a few weeks later, it launched one of the deeply discounted variety, using the spurious justification that since everyone else was having one, it seemed a shame not to join in.

Now there's a profits warning, accompanied by news that the original rights issue is being abandoned in favour of a new, even more heavily discounted one. Meanwhile, in comes the private equity group Texas Pacific with another dollop of rescue capital.

Much huffing and puffing in the City yesterday about the ease with which the original underwriters, UBS and Citigroup, persuaded B&B to let them off the hook. What's the purpose of an underwriting fee, it was being asked, if the insurers get to wriggle out of their side of the bargain at the first sign of trouble?

This is an observation given added piquancy by the fact that, like the other banking rights issues, this one was so steeply discounted that it was hard to see how it could fail. Despite the apparently limited nature of the risk, now that it has crystallised, underwriters are to be let off paying the penalty. Money for old rope indeed.

So why did Rod Kent, the B&B chairman, agree? One reason was that with the profits warning, it became apparent that underwriters had been persuaded to sign up on the basis of a false prospectus.

No legal action was directly threatened, and it would almost certainly have done the underwriters a great deal of reputational damage had they been seen to be trying to junk their obligations, yet they would undoubtedly have had a case. Whether deliberately or otherwise, B&B had not given the underwriters the bottom line. Things were much worse than Mr Crawshaw let on.

The other reason was the arrival of Texas Pacific on the scene. It would have been difficult, to put it mildly, to hold underwriters to 82p a share when Texas was being allowed to buy in at 55p.

What's more, claims Mr Kent, if he had forced underwriters to honour their contract, the company's army of small shareholders would have got nothing when their rights came to be sold in the market.

By renegotiating the terms, the rights are again worth something. This is, of course, a disingenuous argument, as the dilution is also much greater, and the effective loss to shareholders therefore that much bigger.

But I guess it might play some part in getting the proposals through a vote of shareholders, and it is in any case hard to see how B&B could have done anything other than renegotiate the original rights terms once it had decided to bring Texas Pacific in on much more favourable ones.

The "material adverse change" clause in the underwriting agreement also tied Mr Kent's hands. It would have been disastrous for the company had legal shenanigans interrupted the process of capital raising. Once B&B had admitted it needed more capital, it had no option but to complete the process, however harsh the final terms.

Mr Kent insists that B&B is no Northern Rock. The problem is that of profits rather than funding, which is said to be safe at least until next year.

Even so, you have to wonder whether B&B might not have found itself in a similar position but for Northern Rock already having happened. New deposit protection arrangements, which guarantee the full amount of the first £35,000, and the action the Government was prepared to take to safeguard the Rock, ought to make B&B depositors feel safer.

This is a quite dangerous situation, never the less. As we have learned, confidence is an extremely fragile thing when it comes to banking. As for the read across from B&B to other mortgage banks, particularly Alliance & Leicester and HBOS, it is probably not as big as the stock market seems to think.

B&B is a relatively small bank highly exposed to buy-to-let and self-certified mortgages, areas of the mortgage market it has tried to make its own. The deterioration in the mortgage book referred to yesterday is, in any case, largely down to the $4.3bn mortgage book bought over recent years from GMAC. This seems to have been particularly badly monitored.

Still, it beggars belief that a once proud Yorkshire building society could have fallen victim to the valuation fraud referred to in yesterday's profits warning. B&B's only business is that of selling mortgages. It was reasonable to assume that the men in bowler hats knew what they were doing. Plainly they did not, either in terms of managing their mortgage book, or their rights issue.