Sighted in the market — a Basel III attack on a UK bank.
Of course, Diamond Bank would really rather continue being Universal Bank, thank you very much. But diamonds don’t come cheap.
And it’s becoming harder for Barclays to sustain the case for its various alter egos in retail, corporate and investment banking. The cheapness is wearing off this time thanks to Basel III.
Analysts at Evolution Securities factored in fresh Basel rules on the risk weighting of assets plus new strictures on securitisation in a note on Bob Diamond’s creation. And it seems, they haven’t been too happy with Barclays’ recent performance:
In our view, by 2012 76% of Barclays’ equity will be allocated to [Corporate and Investment Banking] – a business for which we forecast a 12% sust. RoE, barely above its CoE. Our Group RoE 2012E is even lower, at 9.5%, after Head Office losses and minorities. Against this backdrop, we think that Barclays’ tNAV should be seen as a ceiling, and not a floor, for its stock…
That’s led to Evolution cutting Barclays to 298p, below even their 2011 estimate of the bank’s tangible net asset value (343p) — because of the issue of costs outrunning revenues. The problem is Barclays Capital, as Evolution note:
We are far from bearish in our forecasts for BarCap revenues: we have long argued that Lehman was a transforming deal that placed BarCap at the top of the investment banking league in Europe. We forecast top line revenues to grow 4% in 2011 and 8% in 2012…
…but cost growth will exceed revenue growth by 3 per cent per annum. Which is perhaps just not good enough for a business facing both regulation costs and the price of its own expansion plans, reckon Evolution’s analysts.
Any additional costs — say those imposed by switching to Basel III — will count. And count hard, according to Evo (emphasis in original):
Barclays reported £62.5bn of markets risk RWA in June 2010 (this level of markets RWA has been fairly consistent during the last 2 years: it was £65bn at the end of 2008, and £55bn by the end of 2009). Barclays does not breakdown markets risk RWA by division but given the nature of the business we think it is fair to assume that the totality of these RWA will reside in BarCap. Assuming that at Barclays the increase will only be 2x – the lowest point of the 2-3x range mentioned in the QIS – BarCap would experience a £60bn increase in RWA in the next 12-18 months.
Barclays might also be looking at some damage to its core Tier 1 capital ratio, as Evolution’s analysts add:
The other major change – this one expected by the end of 2012 – relates to securitisations. Until now, banks deduct the first loss tranche retained from securitisations directly from capital, but only 50% of it is deducted from core Tier 1. From the end of 2012, banks should gross up that first loss deduction converting it to RWA (.i.e. multiply by 12.5).
This has no impact on the capital deductions (for example, a £2bn deduction from capital multiplied by 12.5 would generate £25bn of new RWA, which would consume, using an 8% capital backing, exactly the same £2bn of capital), but there is one key difference: whilst before half of the deduction could go to Tier 1, now the whole increase in RWA will affect core Tier 1 ratio. In a nutshell, the whole deduction will be applied to Core Tier 1 as from 2012, instead of only 50% now.
Barclays currently deducts £2.9bn from securitisations from their core Tier 1 and another £2.9bn from Tier 1: in total, £5.8bn. Multiplying this by 12.5x would give an increased RWA of £72.5bn.
Bob and Basel — probably not the best of friends right now. It’s not just Basel, though:
The FSC [Financial Stability Contribution] announced in the UK Budget will start to have an impact as from 2011. We have adapted our forecasts to the milder-than-expected FSC announced – 4bp in 2011 and 7bp from 2012 onwards – , but still those will have a substantial impact in a business as leveraged as BarCap. With £1trn of assets and no retail deposits, a 7bp FSC should imply £700m more costs p.a. from 2012 onwards…
Now — these could be costs worth bearing for possessing one of the best investment banks in Europe, of course.
It’s harder to say where Barclays goes next in the US, or in its retail decisions, however. Evolution reckon that the bank faces difficult choices over whether to sustain its presence in challenged Spanish and Italian markets, for example.
Well, a retail banking strategy is hard enough. A retail banking strategy faced with co-existing with an investment bank must be harder still.
Related links:
A Diamond Bank break-up? – FT Alphaville
UK banks, sucking on the blood of depositors – FT Alphaville
Baseled and interBank – FT Alphaville