British bank Alliance & Leicester on Wednesday suffered a double blow from the impact of financial market turmoil, warning of sharply higher funding costs to add to a big writedown on the value of risky assets.

A&L, Britain's seventh-biggest listed bank, surprised investors by estimating funding costs will be about 150 million pounds ($292 million) higher this year than under normal circumstances as it takes precautions to avoid the crisis that hit rival Northern Rock last year.

The news, alongside a 30 percent drop in 2007 profits and a gloomy outlook, sent the bank's shares down over 18 percent to their lowest ever level.

A&L suffered a 185 million pound ($360.4 million) writedown on its exposure to assets that have been tarnished by the U.S. sub-prime housing crisis -- in line with guidance three weeks ago. That cut its 2007 pretax profit to 399 million pounds, down from 569 million in 2006 and below an average forecast of 416 million from 12 analysts polled by Reuters Estimates.

The bank reported higher funding costs of 23 million pounds in the fourth quarter and said costs will remain high this year as it had taken prudent measures to increase its level of liquidity and the maturity of its wholesale funding due to the risks of short-term balance sheet financing.

That's come at a cost, but we feel it's the right thing to do to pay the price for security, said Chris Rhodes, the finance director who is also currently standing in as chief executive. We're now talking about a very strong funding position that takes us into Q1 2009.

The costs depressed A&L's net interest margin to 0.93 percent in the fourth quarter and it expects the margin to be about 1 percent this year, down from previous guidance of near 1.07 percent and 1.16 percent in 2007 and 1.3 percent in 2006.

The outlook is for earnings materially below our expectations largely due to narrower net interest margin, Cazenove said in a research note. Our initial reaction is to reduce EPS (earnings per share) for 2008 by 26 percent.

By 4 a.m. EST A&L shares were down 13.3 percent at 458 pence, the biggest UK blue-chip faller, cutting the bank's value to 1.9 billion pounds. Shares sagged as low as 428p, their lowest level since the former building society floated in 1997.

The extent of the higher funding costs hurt other UK banks, notably HBOS, whose shares dipped 1.4 percent.


A&L shares had already more than halved since May, hit by a relatively high exposure to risky assets, given its size, an expected rise in funding costs and modest growth prospects as the UK housing market and economy cool.

The bank calmed worries about funding problems in November as it put in place medium-term deals, which included a 4 billion pound 2-year facility with Credit Suisse.

A&L raised its full-year dividend by 2.2 percent to 55.3 pence per share, below an average forecast of 56.2p, and said it expected the 2008 payout to be maintained at the 2007 level. Its underlying core operating profit rose 3 percent from 2006 to 602 million pounds.

The outlook reads poorly, with volumes down, costs rising, margin guidance slashed, the earnings target cut and the dividend guided flat in 2008 ... the outlook is miserable, with significant earnings cuts likely, said James Hutson, analyst at Keefe, Bruyette & Woods. The only positive may be a white knight (bidder) if the stock falls enough.

A&L warned last month that its writedown on holdings of structured investment vehicles (SIVs) and other complex products related to U.S. subprime housing had more than tripled from a previous estimate to 185 million pounds.

Profit was also knocked by a 10 million pound loss on ineffective hedges and 8 million pounds of redundancy costs.

(Additional reporting by Clara Ferreira-Marques; Editing by Louise Ireland)