Credit where it’s due: the performance of Barclays Capital, through the wild storms in credit markets of the past few months, has been incomparably better than that of Citigroup and Merrill Lynch.
So as I predicted here, the publication of a trading statement has squeezed the bears: Barclays’ share price has bounced this morning.
This is no small achievement. Barclays Capital was a market leader in reprocessing low-quality US sub-prime loans into the allegedly high-grade bonds of collateralised debt obligations. It was (and is) a specialist in converting muck into brass.
And in the past few weeks there has been an unfortunate collision of economic reality and investment-bankers’ wishful thinking: the price of these bonds has collapsed.
The precise mechanism for this collapse has been the accumulating evidence of the difficulties experienced by US homeowners who had borrowed these sub-prime mortgages – which in turn forced the credit-rating agencies to downgrade the ratings of tens of billions of dollars of securities manufactured from these mortgages.
So if you happened to have a load of these securities on your balance sheet, you were not happy.
How has Barclays avoided the calamitous losses of a Merrill or a Citi?
Well it appears to have hedged and reduced exposure at just the right moments: viz just before the onset of the August credit crunch and again just before the tsunami broke over collateralised debt obligations in October.
Luck or judgement? That matters to shareholders in the long term in respect of how they value this business. But right now the overwhelming emotion is relief. For Barclays Capital to be on course to make record profits in this dreadful climate is impressive.
But is the £1.3bn of write-downs for the four months to the end of October really as bad is it is going to get for Barclays Capital?
Is there any wishful thinking in its valuation of impaired assets?
Here is its retained exposure:
1) £3.8bn of exposure to “high grade” collateralised debt obligations linked to sub-prime, where the four-month write-downs seem to have been of the order of 16%;
2) £1.2bn of mezzanine exposure linked to sub-prime, where the write-downs have been of the order of 25%;
3) £5.4bn of “whole” sub-prime loans and a trading book of sub-prime loans and CDOs, which seems to have been written down 7%;
4) Minimal exposure to SIVs and SIV-lites of £700m, where the write-down has been 9%.
Could the value of all that stuff fall further? Of course. Do those write-downs capture in a reasonable way the horror of recent market conditions? Probably.
However, if I have some residual anxiety about Barclays it is about its £7.3bn exposure to the private-equity deals carried out at the peak of the market in the spring of this year.
Just to be clear. I am not suggesting that the businesses it lent to – including Alliance Boots and the company created by the merger of AA and Saga – are likely to run into financial difficulties.
But it has taken a write-down of just 2.5% on these loans, which seems to me to understate the fall in the value of this stuff (and the net write-down is de minimis after adding back a staggering £130m of fees linked to these private-equity deals).
And what about all those rumours that Barclays has been – or could become – chronically short of liquidity?
Well it says it has benefited from inflows of deposits and increased credit lines from counterparties.
And its conduits – those vehicles created by almost all banks as a way of making a turn from raising cheap-short term money to fund long-term assets – seem to be in reasonable shape.
It says they are fully-funded by commercial paper. And that even if all that funding disappeared, the drain on its own resources would be £19bn – which sounds a lot, but is not critical for a business with £1200bn of gross assets.
Does this all mean that it’s back to business-as-usual for Barclays?
Absolutely not. The outlook for credit-markets remains volatile and difficult. And prospects for the economies on which it depends are deteriorating.
But Barclays is in better shape to cope with those difficult conditions than many believed.