Barclays’ conjuring trick

March 30, 2009

– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –

REUTERSAbracadabra! Yet again, Barclays has pulled another rabbit out of its hat. With just days to go before the end-March deadline for the bank to apply for a government guarantee of its dodgier loans, it may again wriggle out of state control.

The Financial Services Authority (FSA) has concluded, after performing “stress tests” on its loan book, that the bank has enough capital. Barclays (BARC.L) has persuaded the authorities and investors (shares are trading at over three times their January low) — of its soundness.

But it should still buy a government guarantee. Thanks to the FSA’s clean bill of health, it can bargain for keener fees than RBS (RBS.L) and Lloyds (LLOY.L). If it does join the scheme, Barclays is likely to present a smaller and more toxic book than the two state supplicants.

Moreover, Barclays is in the happy position of being able to pay cash for the insurance — and cash buyers pay less. That is thanks to the mooted 4.5 billion pound share of its iShares exchange-traded funds business. This is a stroke of luck.

Management were so keen to avoid having Her Majesty’s Government (HMG) on the share register that they raised capital more expensively from Gulf governments last October. Having seen what happened to Asian and other Gulf investors who bought into American banks, the Arabs cleverly inserted an anti-dilution clause when they invested 7 billion pounds.

That means that Barclays is effectively precluded from issuing shares below 153 pence (which any non-government new equity would probably be) unless it wants to risk handing control to them. Of course, Barclays could try to avoid the government scheme altogether.

After all, at 4.5 billion pounds, the iShares sale would boost its tier 1 capital to a respectable 7.7 percent, not so far behind HSBC’s post-rights issue 8.5 percent. And its investment banking subsidiary, BarCap, seems to have enjoyed a storming first quarter.

Citigroup estimates that the whole bank will generate a respectable combined pre-provision, pre-tax 19 billion pounds this year and next. Barclays is planning to resume dividends in the second half but even so, this should add a few points to its capital. Moreover, Barclays claims to have a much cleaner loan book than RBS or Lloyds.

If that’s true, Barclays could in theory sidestep the insurance scheme altogether. Assuming it wanted to end up with a tier one equity ratio of 4 percent, the FSA minimum, it has the scope to write off around 40 billion pounds over the next three years without any further capital injections. To put that in perspective, RBS is thought likely to have to write down 60-70 billion pounds (11 percent of loan assets).

That said, rejecting the government guarantee altogether might demanded too much Voodoo faith even for Barclays poker-faced management team. The bank had 45 billion pounds of “level-3″ assets (whose valuations are unobservable) on its balance sheet (or more than 10 percent of risk-weighted assets) at the end of 2008. True, it also had 21 billion pounds in insurance contracts covering possible defaults in its collateralised loan obligation portfolio within that sum.

But the “monoline” insurers on the other side of that trade are hardly rock-solid entities. Both Ambac and MBIA are on negative watch with the ratings agencies. Instead, Barclays should take some insurance from one of the few counterparties that won’t go under: HMG. Shareholders have had enough magic for the time being, thank you.

- Margaret Doyle has an interest in Barclays shares -

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