Courtesy of the banks team at Nomura.
They see the decision to shun the government’s asset protection scheme as a negative for Barclays’ share price because the market will continue to worry about its portfolio of credit/structured assets. (emphasis ours).
While the strong trading performance to date is a clear positive, we believe that the decision to not participate in the APS is negative for the shares. We remain concerned about the balance sheet exposures to risky assets where uncertainties are likely to persist in our view, as well as by the higher leverage at Barclays as compared to other UK bank peers. In our view, outlook for the shares is likely to remain a judgement between whether the group needs to further strengthen its capital as well as balance sheet and if the risks are effectively in the price. We continue to see downside risk to the shares after their recent strong performance.
The APS, by design would have eliminated tail risks in some of the riskier parts of the asset base as well as provided some confidence to the market around potential write-downs in extreme scenarios. While details of the FSA’s stress test which indicated that Barclays does not need to raise additional capital are not disclosed, Barclays indicates that the test determined resilience to stressed credit risk, market risk and economic conditions. Press reports indicated that the FSA looked at how the loan book would perform over a three- to five-year period in a more severe UK recession than early 1980s.
In 1980-81, quarterly UK GDP fell by -16% as compared to -6% in the early 90s. While Barclays has lower exposure to commercial real estate as well as specialist mortgages as compared to RBS and Lloyds which is likely to be a benefit in such scenarios, we remain unsure of how structured assets (eg Leveraged loans, CMBS and other derived corporate risk) would perform in such extreme outcomes. Write downs on structured assets within the wholesale bank remain essentially unknowable in our view until there is a bottom in real economy asset prices.
Despite the FSA’s stress test, we believe that the credit portfolio is likely to remain a focus. Assets valued with unobservable inputs on the balance sheet totalled £45bn at the end of 2008 which is 1.7x tangible equity. Monoline wraps cover £27bn of notional exposures of which c£18bn is to CLOs with the rest comprised of RMBS, CMBS and other assets. The net exposure to monolines was £8.4bn at 2008 year end, up from £3.6bn at Sept 2008. Exposure to commercial mortgages was £12.3bn marked at 75% while the exposure to leveraged loans of £7.3bn is valued near par.
Barclays capital ratios also appear weaker than at the peer group, post the capital strengthening moves which include the sale of iShares and a potential debt swap. The group does appear to need to strengthen its ratios. The issue is how significant the dilution from this process proves.
The pro forma ordinary equity Tier 1 ratio was 6.1% at year-end, compared to 8.8% and 10.2% at Lloyds and RBS post the APS schemes. Raising the ordinary equity Tier 1 ratio to 9% would require £13bn. The iShares sale could add 75bp to this ratio. Even with a further 65bp from a debt swap, it is difficult to see the group get to peer group levels, without an equity raise. Furthermore, on a simple leverage ratio basis, Barclays equity to adjusted assets ratio is 2.6%, compared with figures of 3.3% and 3.7% at Lloyds and RBS respectively. Raising the leverage ratio to 3.5% would require £9bn.
More reaction when, and if, we get it.
Related links:
Barclays shuns insurance plan – FT.com
Barclays to Treasury: Keep yer money – FT Alphaville