– Margaret Doyle is a Reuters columnist. The opinions expressed are her own –
Barclays’ and HSBC’s interim results are a study in contrasts. Barclays has used the credit crunch to make a bet-the-farm move into the investment banking big-league, a bet that has so far paid off. HSBC, in comparison, chastened by its flawed move into the U.S. subprime market, has returned to its conservative roots.
John Varley, Barclays’ chief executive, gives the usual guff about “staying close to our customers and clients”. In truth, Barclays’ 3 billion pounds of profit in the first half owes much more to its investment banking division, enlarged by its opportunistic acquisition of Lehman Brothers’ North American unit last autumn, than to its traditional banking businesses.
Barclays Capital (BarCap) more than doubled revenues to 10.5 billion pounds, and doubled pre-tax profits to 1 billion pounds. As with rivals, the star performer was fixed income, currencies and commodities where banks are profiting thanks to their access to very cheap central bank funding.
This is just as well, because Barcap is still carrying plenty of toxic assets left over from the credit boom. These cost it 4.7 billion pounds in gross writedowns and impairments in the first half. Given that it still has other dodgy exposures, including assets worth more than 7 billion pounds guaranteed by ailing monoline insurers, further losses seem likely. Barclays cannot rely on other parts of the bank to come to its rescue: profits in traditional retail and commercial banking businesses all collapsed as impairments soared.
HSBC’s global banking and markets (GBM) division also delivered a record performance, more than doubling its first-half profits, to $6.3 billion. However, HSBC has long resisted the charms of investment banking, and runs GBM as a complement to its existing global commercial banking franchise. Despite the juicy returns currently on offer, this is unlikely to change.
HSBC has its own sizeable bit of historical baggage in the form of Household, the U.S. consumer lender that is now being expunged from the record, though not without considerable additional losses.
Many suspected that HSBC would use its bumper $17.8 billion rights issue this spring to acquire divisions of ailing rival banks at bargain basement prices. So far, it has resisted, instead bolstering its tier 1 capital ratio to 10.1 percent.
Rather, it is building on its position as the world’s leading international bank (especially now with Citi holed under the waterline) organically. While cash-strapped rivals retreat from China, HSBC is investing in its Chinese operations. It has been the first international bank to settle cross-border trade in renminbi (yuan). It is on track to have 100 outlets, including many in rural China, by year end, more than any other international bank. Such loyalty will not go unnoticed in Beijing.
Which bank is better positioned for the new environment? That depends partly on the speed of the recovery. Barclays has so far performed a dazzling high-wire act, avoiding state capital by spreading its losses over a number of years and by selling its Barclays Global Investors arm. But this is hard to sustain if the downturn turns out to be prolonged. Meanwhile, once banking conditions return to normal, central banks will cease to flush investment banks with cheap cash and investment banking profits are bound to tumble. The HSBC tortoise looks set to leave the Barclays hare far behind.

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

One of the challenges for bond investors over the coming years is how to deal with the enormous ballooning of government debt that is happening as a result of the credit crisis.

Traditionally, investors allocate funds between asset classes and require managers to manage to a benchmark. However, most indexes are based on market capitalisation: the securities with the biggest value in aggregate have the largest share of the index.

This is less than ideal in equity markets, where indexing can lead to herding by forcing investors to buy overvalued shares. But it is particularly perverse for bond investors. The countries with the largest weightings in the indices are those that have issued the most debt.

At present those are the countries with the most colossal deficits to finance. So, traditional index-tracking bond funds are being obliged to allocate more money to precisely those countries whose creditworthiness is decreasing fastest.

PIMCO, the world’s biggest bond investment manager, has come up with a new index — the Global Advantage Bond Index (”Gladi”) — that tries to get around this problem.

Gladi, which is being administered by Markit, a global index provider, is weighted by national income rather than by historic debt issuance. When initially launched, after 2 years of research, earlier this year, it was pitched as a way of “building in a tilt toward these countries that are developing rapidly but their capital markets and market capitalization haven’t caught up yet.”

However, now it is being marketed as a way for pension fund trustees and other investment managers to avoid increasing their exposure to the debt of countries like the United States and the UK, which are planning to issue trillions of dollars worth of bonds over the next few years to pay for their bank bailouts and to stimulate the economy.

Indeed, PIMCO reports that some clients want to avoid government bonds — which account for around 50 percent of traditional bond indexes (the remainder is roughly split 50/50 between corporate bonds and various mortgage-backed securities), altogether.

In the past, governments have found cunning ways of increasing demand for their bonds, whether patriotism, to flog war bonds, or requiring insurers to hold more “safe” gilts as a hedge against long-term liabilities. Now regulators are going to require banks to hold more capital, and more of it in the form of liquid instruments, i.e., government bonds.

However, they will also need to persuade non-bank investors to buy their bonds if the interest burden is not to spiral out of control. And unfortunately for the deficit-hit governments, investors seem to have seen them coming.

(Editing by David Evans)

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

George Osborne’s plans to break the British addiction to debt have drawn protests from some business groups. He should not be put off. If a Conservative government with him as Chancellor can offer the quid pro quo of a cut in the rate of corporation tax, business should welcome the move.

Under today’s rules, British businesses have every incentive to finance themselves by borrowing: not only is interest typically lower than the return that shareholders demand, but all interest is tax-deductable. This anomaly was criticised as long ago as 1978 by James Meade, the Nobel laureate, but the position has worsened since then. Pension funds used to be able to reclaim the tax on dividends, but that concession was removed by Gordon Brown in 1997. As has recently become painfully obvious, this regime has significantly increased financial instability.

Given the impact on corporate finances, such a fundamental shift needs careful management. It cannot be done quickly, and an acute recession is not the best time to impose it, but it might be a good time to signal that it’s coming. Business is risky, and equity has proved itself over time as the best way of raising the finance to back it.

Among the critics of any threat to interest relief is the British Venture Capital Association, the trade body for private equity, the industry that has turned equity in its businesses to little more than option money. Typical capital structures ensure that the corporation tax bill is minimal, while even a small rise in operating profits can translate into massive gains for shareholders. If things go wrong, losses fall on the providers of the debt.

Banks which provided the debt have been burned by their exposure to over-leveraged companies. Unfortunately, they cannot be relied upon to remember the lesson once the current conditions fade into history. A tougher problem lies with multinational businesses. The UK allows companies to offset interest on debt raised anywhere in the world, at the cost of its corporate tax base, which has encouraged them to come here. Osborne’s plan to reduce the deductibility of overseas debt risks sending them away again, so he needs to tread carefully.

The carrot is a cut in corporation tax from 28 percent to 25 percent or as far below it as he can afford. Each cut reduces the attraction of higher gearing and the complex (and expensive) devices needed to maximise the current tax relief. Given the improvement lower corporation tax would bring to Britain’s competitiveness, the price of lower interest deductibility is well worth paying.

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

Germany's politicians seem to have rescued their bad bank. Pushing back the valuation date for toxic assets to before the Lehman collapse has made it more likely that banks will consign their dud investments to the voluntary scheme.

It had looked as if the banks might simply boycott it. However, while the government has scored a political goal, it is no closer to its aim of boosting lending to a credit-starved German economy.
The essence of the scheme is that banks will be able to transfer some 250 billion euros of toxic assets into "eine Bad Bank". In exchange they receive government-backed paper that they can count towards regulatory capital.

In principle this will raise their lending capacity. However, because the Germans do not want to reward reckless banks, the banks will pay an annual fee to participate, and will be liable for any shortfall at the end of the scheme. In other words, there is no fundamental risk transfer from the banks and the uncertainty about their eventual liability remains.

The breakthrough this week is that the government has pushed the valuation back to before the collapse of Lehman last autumn -- when valuations were much higher.

One of the perverse effects of the revision is that some banks may enjoy a gain on the value of their impaired bonds because they have already been written down. This explains why shares in Commerzbank jumped by almost 20 percent when the news emerged on July 1.

However, like the original plan, the amendment is simply a sleight of hand. The government is still putting no cash into the scheme. The German public is dead against bailing out reckless banks, and the government, mindful of September's general election, is in no mood to trifle with voters.

All that this plan does is to buy the banks time. Indeed, by giving the banks a higher starting value, the government is increasing the annual charge that banks will have to pay.

The risk is that banks will behave according to this economic reality rather than to the accounting and regulatory fiction conjured up by the government. Under pressure from shareholders to return to health, they may shrink their balance sheets and curtail lending.

Merkel may have succeeded in avoiding a bailout of Finanzplatz Deutschland for now, but perhaps at the cost of financing Deutschland AG.

(Additional reporting by Paul Taylor)
(Editing by David Evans)

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

The crisis at Northern Rock marked the beginning of Britain’s slide into large-scale state ownership of the banking system. Returning the mortgage lender to the private sector would be a sign that normal service is being resumed. But rumours that the British government is poised to sell Northern Rock, are premature. Suggestions the government could do so at a profit are even more far-fetched.

Prime Minister Gordon Brown is apparently keen to offload the Rock, ideally “at a substantial profit” before the general election, which must be held before next summer. According to the Times, the prime minister “wants desperately to avoid a Conservative government taking the credit”.

It would be lovely to think the government’s main worry is who might benefit from the “profits” from the banking bail-out, rather than the substantial losses it has underwritten at the state-owned banks. There are plenty of thorny matters to be settled before the Rock is sold.

The government itself has two conflicting objectives. As a shareholder, it wishes to sell its stakes as soon as it can, and to be able to dress up the sale as a profitable exit. However, as the guardian of the economy, it wants to moderate the rate at which the banks shrink their balance sheets, because that denies credit to viable businesses and would-be homeowners. Indeed, the government recently instructed the Rock to stop shrinking its balance sheet and to start lending again.

This is why the European Commission, which has to approve the bailout under its state aid rules, has demanded more information from the Rock. Given the tough stance Neelie Kroes took with Germany’s Commerzbank <CBKG.DE>, the EU competition commissioner is also likely to look closely at a Rock that is growing again thanks to its government backing.

Even if the Rock can negotiate this hurdle, the idea that the government could turn a quick profit on the bank is fantasy. The current plan is to split the Rock into two companies: a BankCo, which would hold the branches, deposits and new loans and AssetCo, which would hold the bulk of the legacy mortgage book. It is hard to see rivals falling over themselves to buy the Rock’s low-quality mortgage book. While there may be interest in the Rock’s branches and deposits, the price is likely to be minimal.

Santander paid just 150 million pounds for Bradford & Bingley’s 197 branches and 21 billion pounds of deposits. (The government took on the bank’s 50 billion pound loan book). The Rock has just 75 branches and though it has a similar deposit base, some of these savers would be likely to rethink their allegiance if the bank was returned to the private sector.

Any proceeds would have to be set against the money the Rock owes the government. This stood at 9.8 billion pounds as of March, and the government is expected to inject at least another 3 billion pounds to boost the Rock’s capital ratios, which are now below the minimum required by regulators. Gordon Brown can rest assured. No one is going to be turning a quick buck on the Rock any time soon.

(Edited by David Evans)

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

Three months is a long time in the markets, and particularly for banks. Alongside the rally in bank shares, investors have also bid up bank bonds, especially so-called tier 1 bonds which rank just above the equity in the list of creditors.

In some cases, the prices these bonds have tripled and, overall, yields to perpetuity have halved across the sector, according to Morgan Stanley.

This rally has now overshot and the risks are on the downside. Despite being labelled debt, tier 1 is pretty much like equity: issuers can stop paying coupons, the coupons do not always accumulate if missed and the issuer can choose not to “call” (redeem) them at the call date.

So the additional protection they offer over bank equity is not great. This is why prices crashed last autumn along with those of bank equity.

Over the past couple of months, confidence has returned as governments across Europe have recapitalised their banks, removing the risk of a systemic failure.

The ensuing confidence has enticed private banking clients — who are missing the income traditionally provided by dividends and bank interest — into this market.

Moreover, banks have themselves been buying back their own debt, trying to lock in the “profit” that many have booked on the write-down in the value of their debt.

Institutional investors have committed much of their substantial cash holdings to this market too. These factors have driven up prices.

However, the juicy yield that has enticed recent buyers may simply disappear: issuers could simply pass the coupon.

This is what has happened with Bradford & Bingley, a failed British bank whose loan book is being run down by the British government. Last week’s announcement failed to damage other bonds, suggesting that investors see B&B as a special case.

This assumption may prove too optimistic. Most banks are short of cash and will be tempted not to pay their tier 1 coupons if they do not have to.

This is especially true of state-owned banks, like RBS and Lloyds, and Ireland’s AIB and Bank of Ireland that are not paying dividends.

Their state paymasters may consider “optional” coupons to be a poor use of precious capital.
Moreover, the European Commission may stop them from doing so. It has already prevented Commerzbank from paying out on hybrid bonds.

The Commission is currently examining the British and Irish state guarantees and may conclude that insolvent banks should not be making discretionary payments to bond-holders who, after all, are typically institutional investors who should understand the risks inherent in such instruments.

The biggest risk — that investors will be wiped out by nationalisation — has not gone away, even if it has subsided.

If banks do need any more government bail-outs, the terms are likely to be harsher than in the past. Even in the absence of full-on nationalisation, governments may choose to impose a debt-for-equity swap on bondholders.

After all, everyone else — depositors, shareholders, taxpayers — have borne some pain. Why should bondholders be any different?

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

Apparently, investors in Man Group’s flagship fund value liquidity and safety above performance. At least Peter Clarke, the company’s chief executive, hopes so.

He needs them to do so because, over the last five months, the investors in AHL, Man’s “black box” quantitative fund, have been suffering. Unlike many rival funds, Man did not “gate” its funds during the market panic, and Clarke believes that investors will remember this and reward Man for it.

Clarke says that the punters, who account for the bulk of Man’s $44 billion of funds under management, bought $2.6 billion of Man’s funds since the end of March, but the institutions are still running for the exit.

Moreover, private investors are switching out of guaranteed products, which put a floor under investors’ losses and which generate a higher margin for Man, into lower-yielding open-ended funds. Moreover, institutional investors are continuing to withdraw their money.

Man maintains that they are taking cash out because they can — other funds remain locked up-and that the trend will moderate soon. As Clarke put it, investors are looking for more exposure to the market.

However, quantitative, “black box” funds, like AHL or the famed Renaissance Technologies in the U.S., which follow market trends, are designed to do well whatever the market does. Perversely, this means they often do badly when the market does well.

AHL did well last year, generating a return of 33 percent when world stocks fell almost 40 percent. However, it completely missed out on the recent rally.

As Man admits, it does cope well when the market whipsaws. Man is investing in a new Oxford research centre. However, any new algorithm is unlikely to come fast enough to address the collapse in its assets under management.

This has had a catastrophic effect on both performance and management fees, driving a 40 percent fall in profit last year. Clarke says that he sees no pressure on the 4 percent-plus annual fee that Man charges its private customers.

He has, however, detected a demand for transparency. Once investors see how much they are paying for Man’s products — especially when they are not performing — they will continue to put their money elsewhere.

(Edited by David Evans)

Well-intentioned legislation often has the opposite effect. The European Commission’s new alternative investment directive threatens investment trust companies, an attractive form of pooled investment.

The Commission aims to “enhance investor protection.” However, in addition to hedge funds, the original French and German target, investment trusts would be caught in the new regulatory net. Unlike other pooled funds, investment trusts offer transparency, low fees, the discipline of a public limited company and a vote.

For retail investors, trusts offer a cheap and easy way to diversify their investments. Because they are PLCs, they are subject to the British Companies Act, and the directive offers nothing by way of improvement. Moreover, it would impose obligations that may be impossible to meet.

Investment trusts have been around since 1868, when Foreign & Colonial enabled individuals to put money into the United States. Now, some 434 London-listed trusts manage around 75 billion pounds. They allow investors to put money into India and China, private equity, property, collateralised loan obligations and every other corner of the market.

They differ from unit trusts in that they are closed ended, i.e. the size of the portfolio is unaffected by shareholders buying and selling. Management costs tend to be low and, because they are closed-ended, the only other cost is the market spread on the shares.

The new directive would require funds to be independently valued. This is irrelevant for trusts. The transparency directive already obliges trusts to produce quarterly figures, but most trusts produce a daily net asset value. They already have an independent board that oversees valuation, and can sack the manager for poor performance.

Another provision of the directive seeks funds to offer immediate redemption of their investment. This is incompatible with the PLC structure. Investors can already trade shares daily in the open market — they simply have to take their chance with the share price on the day.

The directive limits “alternative” funds to professional investors, which would bar investment trusts from the investors who have most to gain from buying them.

Investment trusts companies are a British investment phenomenon. The Association of Investment Companies hope simply that the Commission has simply not thought about them.

The simple solution is to exclude any share traded on an EU-regulated exchange. Otherwise, this risks looking like another poke in the eye for “Anglo-Saxon capitalism”.

(Edited by David Evans)

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

Willie Walsh has no incentive to be bullish right now. He has had British Airways on cold rations since joining as chief executive-designate four years ago, and another set of tough union negotiations looms.

However, a poor set of annual results shows that — even had he wanted to — there is no disguising the pension situation: dire and getting worse.

The accounting deficit widened by 1.2 billion pounds last year. Even that picture is reckoned to be too optimistic.

That is because the bean-counters use AA corporate bond spreads to discount future liabilities. Corporate bond spreads are very high right now, which has the perverse effect of reducing liabilities just because investors are becoming more risk averse.

Citigroup expects that the more realistic actuarial triennial valuation — due this September — will show a deficit of between 3 and 3.5 billion pounds.

At the upper end, that is almost on a par with BA’s gross debt and is almost twice the airline’s battered market capitalisation.

In principle, BA is on a ten-year programme to eliminate its deficit by 2016. In practice, the airline will need more time.

Britain’s Pensions Regulator, David Norgrove, recently introduced new guidelines to cut companies some slack during the downturn.

He said that employers could take longer than the usual decade to close the deficit. And he suggested that companies could make non-cash contributions in situations where they are cash-strapped. However, he also made it clear that companies could not continue to pay dividends at the expense of contributions to the pension scheme.

BA has passed this year’s dividend. Moreover, unlike many banks, it is not paying management bonuses and is freezing base pay. In today’s recessionary times, the pensions flexibility will be very welcome to BA.

It admitted that the pension liability “may…affect our ability to raise additional funds.”

Moreover, the pensions trustees will have a say in any tie-up, like the mooted merger with Iberia, or the joint venture with Iberia and American Airlines, which is in a holding pattern as competition regulators chew over the deal.

Trustees are becoming more imaginative about the sort of bargains that they strike with their sponsor companies.

It is in no one’s interest for the pension fund to cripple the company that sustains it. The pension fund should not take on too many company assets-otherwise it risks being hit by exactly the same forces currently bashing the airline itself.

However, assets like scarce Heathrow landing slots, have a resilience, whatever the economic weather. A trade of slots for pension contributions might just fly.

(Edited by David Evans)

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

Sir John Ritblat, founder of British Land, was a believer in “buy and hold.” Fortunately for shareholders, Stephen Hester, brought in as chief executive ahead of Ritblat’s retirement in 2006, took a more active view of asset management.

He shifted almost 7 billion pounds-worth of property off the books over 3 years before shifting himself to RBS. The Broadgate Centre remains, but is for sale at the right price. Foreign buyers, lured in by cheaper sterling, might like to take a look.

Chris Grigg, Hester’s replacement, says nearly all of its property has been let, including the massive development at Ropemaker Place in the City of London. However, the two Japanese banks who signed up will enjoy four years rent free, which puts the headline rent of 47 pounds per square foot into perspective.

British Land points out that almost all leases are subject to upward-only rent reviews, but it’s hard to see any increase. Landlords cannot ignore the health (or otherwise) of their tenants. Meadowhall, British Land’s shopping centre near Sheffield, has reduced service charges by 20 percent in response to the shopkeepers’ pain.

Fortunately for Grigg, the balance sheet has been braced with 740 million pounds from shareholders and there is 3 billion pounds of undrawn bank facilities.

The shares are trading close to the new net asset value (NAV) of 398 pence per share, down 64 percent over the year. Collins Stewart calculates the bottom of the cycle NAV at little more than 2 pounds per share, so a return to the good times is already priced in. It could be a long wait.
(Margaret Doyle owns shares in British Land)