June 19 (Bloomberg) -- HBOS Plc, the U.K.'s biggest mortgage lender, warned house prices will fall as much as 9 percent this year, more than it earlier forecast, forcing more borrowers to default on home loans.

HBOS dropped 6.9 percent in London trading today and Standard & Poor's lowered its outlook after the bank said in a statement that ``continued softening in the economic climate'' will push up charges for bad mortgages. The Edinburgh-based company wrote down an additional 200 million pounds ($395 million), including stakes in homebuilders, and said risks related to bond insurers almost tripled to 1.5 billion pounds.

``The quality of the Treasury portfolio has deteriorated significantly,'' said Robert Law, an analyst at Lehman Brothers Holdings Inc. in London who has an ``underweight'' rating on the stock. ``This is a negative read-across to the U.K. bank sector and indicates the pace at which housing related sectors are seeing declines in profitability.''

Chief Executive Officer Andy Hornby plans to sell 4 billion pounds of shares next month to shore up capital. That's roughly the same amount as total asset writedowns at HBOS since the credit crunch began last year. Its rights offering will follow a 12.3 billion-pound share sale by Royal Bank of Scotland Group Plc and a surge in missed mortgage payments that forced Bradford & Bingley Plc to cut the price of its planned offering.

HBOS declined 22 pence to 296.75 pence, valuing the bank at 11.1 billion pounds. The shares are down 60 percent this year, more than twice as much as the eight-member FTSE All-Share Bank Index. S&P lowered its outlook for HBOS's counterparty credit rating to negative from stable, it said in a statement today citing the ``weakening U.K. economy.''

Lowest Since World War II

U.K. housing starts will probably sink to the lowest since World War II ended, the Construction Products Association said this week. The Royal Institution of Chartered Surveyors said earlier this month the decline in home prices reported by its members is the most widespread since it began its surveys in 1978.

HBOS predicts U.K. mortgage lending will drop 45 percent this year. The bank, the U.K.'s biggest mortgage lender with a 20 percent share of the market, forecast in April that home prices would drop about 5 percent this year and in 2009.

The company said bad loans rose 17 percent to 4.95 billion pounds as of May 31 from 4.23 billion at the end of 2007. Late mortgage payments by ``specialist'' customers including landlords and borrowers whose incomes weren't verified rose to 3.1 percent of total mortgages from 2.6 percent. They are ``in line'' with its forecast, HBOS said.

Credit Default Swaps

HBOS has risks related to bond insurers that sold credit default swaps to protect fixed-income securities. As bond insurers are downgraded by rating agencies, ``it becomes more likely that the banks that have bought protection from them will suffer further writedowns,'' analyst Simon Adamson of Credit Sights said in a note to investors.

HBOS said in April it wrote down 2.8 billion of Treasury investments. The figure was ``almost identical'' as of May 31, Hornby said today.

``The focus will be on the deterioration in asset quality,'' said Mark Phin, an analyst at Keefe, Bruyette & Woods Ltd. in a note to investors.

Profit margins will be ``stable or improving in 2009,'' Hornby in an interview today. The bank forecast a ``stronger'' second half and ``resilient performance'' for the full year.

HBOS, Bingley, England-based Bradford & Bingley and Leicester-based Alliance & Leicester Plc, relied on wholesale markets for more than half of their funding. They have curtailed loans following the seizure in credit markets and higher costs for loans between banks.

Bank of England Assistance

Alliance & Leicester fell 5.7 percent in London to 304.25 pence, bringing this year's drop to 53 percent. Bradford & Bingley declined 1.4 percent to 72 pence and is down 73 percent this year.

HBOS has used the Bank of England's new liquidity plan and plans additional borrowing, Finance Director Mike Ellis told analysts on a conference call today. The program, announced earlier this year, is designed to increase banks' liquidity by allowing them to trade their mortgage-backed securities for Treasury bonds.

Chancellor of the Exchequer Alistair Darling said late yesterday he will give the Bank of England more power to fight the financial crisis. The Treasury will give the central bank an explicit mandate for overseeing financial stability and create a panel to regularly discuss threats to the banking system, in the biggest shakeup of U.K. economic policies since 1997.

Pressure on Underwriters

HBOS fell below the 275 pence-a-share price for its rights offering last week, leading to speculation that underwriters Dresdner Kleinwort Group Ltd. and Morgan Stanley may be left with unsold stock. HBOS rebounded after the U.K.'s Financial Services Authority said it would force short sellers to disclose trades during rights offers.

HBOS said today it will pay 160 million pounds for costs related to the rights issue, including fees paid to the underwriters. Shareholders vote on HBOS's offer on June 26 and the new shares are set to begin trading in London on July 21.

HBOS will sell two new shares for every five existing shares to achieve a ``step change'' in capital strength, the company said in April. It will have a core Tier 1 ratio, a measure of financial strength, of between 6 percent and 7 percent after the rights issue, HBOS said today.

HBOS wrote down 100 million pounds on its stakes in U.K. homebuilders. It bought a 40 percent stake in Tulloch Homes Group for 27.5 million pounds in April and has investments in other developers including McCarthy & Stone Plc and Crest Nicholson Plc.

Lending and investments in homebuilders totaled 4.2 billion pounds as of May, HBOS said.

To contact the reporter on this story: Jon Menon in London at jmenon1@bloomberg.net

Last Updated: June 19, 2008 12:18 EDT