Barclays released its much anticipated 2008 results on Monday, to general approval. Not sure how to take things at first, the market eventually reacted positively, and Barc’s shares were trading up 11 per cent not so long ago.
Although there are several one-off gains in the numbers (£2.4bn+ in negative goodwill from the Lehman acquisition, for example), the feeling was that the underlying results were certainly peer-outperforming.
On which note, if you like your morning lattes milky and your banking executives sympathetically lit, then the 40 pages of Risk Management technicalities (out of 126 pages, toto) in today’s earning’s aren’t for you. Click instead here, for the audiovisual version: Frost/Nixon PR/Varley.
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One thing sector analysts did note in particular, amid the good-news gospel, was the rather explosive growth of Barc’s balance sheet: total assets were reported at £2,053bn. Compared to £1,227bn in 2007.
The proximate cause for that:
… a growth in the value of the bank’s derivative position from £248bn a year ago to stand at £984bn currently. The notional size of Barc’s derivatives book, by the by, is even more eyewatering: $45.7 trillion.
Barc’s exploding derivative position might seem alarming, but it’s not really unusual. The bank notes (emphasis ours):
The £737bn (2007: £110bn) increase in the gross derivative assets has been predominantly driven by significant volatility and movements in yield curves during the year together with a substantial depreciation in Sterling against most major currencies.
Derivative assets and liabilities would be £917,074m (2007: £215,485m) lower than reported under IFRS if netting were permitted for assets and liabilities with the same counterparty or for which we hold cash collateral.
The massive growth in Barc’s derivative positions reflects a changing set of risks that the bank is coping with. Risks which, QED, are being managed by derivative hedges with other institutions. A decline in Sterling that would otherwise have sunk Barclays has thus been averted by the extensive exchange rate swaps Barc will have sensibly written into most – probably all – of its foreign deals.
The derivative explosion in other words, shows derivatives working, not derivatives failing. All of which is not to say the risks are minimal: as should be pretty clear, counterparty risk is a huge issue, especially since these contracts are largely unregulated and certainly, as we are increasingly seeing, prone to legal challenge.
Moving on from the derivative spectacle though, there are a couple of other troubling points from the Barc Risk Management tables which augur potentially badly for the bank in the future – and may yet be a source of further deep writedowns in 2009, depending on the severity of the downturn.
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Page 55 details Barclays’ leveraged finance exposures.
The bank currently has £7.3bn of leveraged commitments, impairments against which so far have been minimal.
It’s up in the air really, but we just don’t see how some of these positions can’t go bad. On the other hand, in Barclays’ favour, assuming these are private-equity LBOs, then perhaps there is something to be said for relationship lending and the likelihood that these companies will make it through thanks to some PE firm’s favoured client statuses. Who knows. Rather in support of that positive argument is the fact that Barclays saw a £3bn leveraged loan repayed at par just last month, thus considerably reducing its position.
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Page 57 has detail of Barclays’ CLO exposures. It illustrates quite a big issue for Barclays that many analysts have noted before. The bank is still very dependent on monolines to hedge some of its large structured finance positions.
And just because CLOs aren’t subprime, doesn’t mean they’re not losing a lot of value:
As the above table shows, Barclays have £20.8bn of CLOs “wrapped” by monoline insurance. And rather predictably, given what has been happening in the secondary loan market of late, the value of those underlying CLOs has declined rather nastily. Barclays now judges the underlying CLOs on that position to have decline in value by £5.7bn, to £15.1bn.
And yet so far, the bank has only taken a writedown of £833m – leaving a £4.9bn writedown which is magicked into the ether by £2.3bn of hedges with AAA or AA-rated monolines, £1.4bn of hedges with A/BBB-rated monolines and £1.1bn of hedges with junk monolines.
This is all fine assuming that a) the monolines can continue to hobble along in run-off mode for the next few years and b) the value of the underlying CLOs continues to hold up. (In no small part, of course, is a) dependent on b).)
Again, as with those leveraged finance positions, we don’t see how CLOs aren’t going to suffer badly if the corporate default rate is as bad as it is projected to be through 2009.
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All of this is, of course, just balance sheet number scansion: looking for likely stresses rather than necessarily actual ones. And indeed, it isn’t to say that Barc doesn’t have a lot of favourable things to note in its outlook: secure funding, sound liquidity and the huge benefits of the FSA’s changed bank regulatory capital regime yet to work through.
Still, thoughts to bear in mind.