Shares in Barclays were up 15% at 113p in early trading on Monday, recouping some of the previous session’s losses.
But how much of this is down to Friday’s statement that profits for 2008 would be well ahead of market forecasts (£5.3bn)? Not much, we would suggest.
Merrill Lynch is surprised the strong profit performance at Barclays has not translated into better capital ratios:
On Friday evening, Barclays responded to the 25% drop in its share price by issuing a statement saying that a) PBT should be ‘well ahead’ of consensus of £5.3bn (ML(e) £4.6bn) and b) the core tier 1 ratio (on the co. basis) will be ~6.5%.
We were surprised that the strong profit performance has not translated into better capital ratios. Barclays has produced 2H08 PBT of >£2.5bn, but seen 110bps of core tier 1 ratio deterioration. We think the primary cause of this was faster RWA growth than expected: assuming a profit of £5.8bn for the year would imply RWAs of ~£445bn, versus £353bn at 1H08 and ML(e) £387bn at year end.
We believe this was due to a combination of currency moves (RWAs in USD and EUR) and Basel 2 procyclicality. 6.2% core tier 1 ratio might cause concern Barclays’ expected core tier 1 ratio of ~6.5%, includes ~30bps of regulatory deductions, which we prefer to ignore, giving a year end core tier 1 ratio of ~6.2% on our basis. Given the capital position of European peer group banks (sector average 7.2%), we think that Barclays’ relative position looks less comfortable than before this announcement. In addition, any further GBP weakness could cause capital ratios to suffer further, owing to the lack of hedging in the capital base.
And Dresdner Kleinwort is equally unimpressed:
We are concerned that the profit update is insufficient to bring investor concerns down. A possible future shortage of capital following further asset deterioration could eventually push the bank into the arms of the government if existing shareholders are unwilling or unable to provide yet further support and share price weakness persists. The support terms offered by the UK government may not be as favourable as given to its domestic peers. We reiterate our Underweight recommendation on Barclays. Barclays 5yr senior CDS is currently trading at 155/175bps.
So, it would seem this rally is more in relief that the package of measure announced by the government does not include a ‘bad bank’ into which Barclays would be forced to transfer assets.
Indeed, the terms of the alternative – the Asset Protection Scheme — are not as punitive as feared – i.e. the fee to use the scheme can be paid in cash rather than new shares.
From Monday’s statement:
2.1 Under the Scheme, in return for a fee, the Treasury will provide to each participating institution protection against future credit losses on one or more portfolios of defined assets to the extent that credit losses exceed a ‘first loss’ amount to be borne by the institution. It is intended that the Scheme will target those asset classes most affected by current economic conditions.
2.2 The Treasury protection will cover the major part but not all of the credit losses which exceed this ‘first loss’ amount. Each participating institution will be required to retain a further residual exposure, which is expected to be in the region of 10 per cent. of the credit losses which exceed the ‘first loss’ amount. This residual exposure will provide an appropriate incentive for participating institutions to endeavour to keep losses to a minimum.
2.3 The Treasury currently expects that the fee will usually be satisfied by the issue of capital instruments of the participating institution. These instruments are not expected to include ordinary shares, but will include a range of alternative capital instruments. The Treasury will be open to consider other forms of fee, including cash.
However, Barclays still finds itself in something of a Catch 22.
If it decides to use the scheme it will have to issue capital instruments to the government or raise cash, which in all probability means tapping its friends in the middle east again. How keen they will be to stump up more money when their existing investments are under water is open to question.
But if Barclays decides not to use the scheme, the market will ask why and probably assume the worst. In which case there is a chance Monday’s rally fizzles out and the shares are soon languishing around 100p again.
Related links:
HMT actions summary – FT Alphaville
BoE becomes bad bank – FT Alphaville
Her Majesty’s AIG – FT Alphaville
HMT on RBS – FT Alphaville