Showing posts with label Barclays. Show all posts
Showing posts with label Barclays. Show all posts

Friday, June 27, 2008

Citigroup thinks Barclays needs more

Well you don't say:

June 27 (Bloomberg) -- Barclays Plc, Britain's fourth-biggest bank, may need an additional 9 billion pounds ($17.9 billion) to absorb credit-related writedowns and bring its capital in line with U.K. peers, Citigroup Inc. said.
The London-based bank will raise 4.5 billion pounds in a share sale announced earlier this week, lifting its core-equity Tier 1 capital ratio to 5.8 percent from slightly below 5 percent, said London-based analysts led by Tom Rayner in a research note today. That will lag behind Royal Bank of Scotland Group Plc and make Barclays Europe's ninth weakest bank in terms of capital, said Rayner, who has a ``sell'' rating on the stock.
``With credit market conditions continuing to deteriorate globally, we believe it is simply a matter of time before further significant writedowns are taken,'' Rayner said.
Barclays spokesman Alistair Smith couldn't immediately be reached for comment.


Sack Bob Diamond. Sack him now.

Thursday, June 19, 2008

In praise of fraudulent accounts

I wound up having a chat about Barclays with the head banking analyst from a major European broking house. He hit me with the “how is it possible” line about the assets being as miss-marked as I privately think. He talked about auditors and regulators and the like.

I thought that was shockingly naïve – because I am not even sure that miss marking is now the point.

Go back to my first substantive post on this blog. It was about scoping the US mortgage crisis. Seeking Alpha – who I originally sent the column to – changed the heading of this post to imply that the mortgage crisis is not as bad as it seems. (Did they read it?)

Anyway – in that post I note that it is quite common to be able to buy AAA strips of diversified non-standard (but not intentionally subprime) mortgage securitisations for 80c or less on the dollar.

This implies a shocking level of system losses.

In the old days a typical mortgage securitisation had 12 percent “protection” before you got to the AAA strip. For the AAA strip to default you needed something like 30 percent of the loans to default with a loss-given-default (or severity) of 40 percent. This was unthinkable – and so it was considered reasonable that the AAA strips covered 88 percent of the pool. I noted in the first post that for many Alt-A issuers I could not have ex-ante faulted that logic.

Well the unthinkable has happened. There are numerous pools where the defaults will be greater than 30 percent or the severity greater than 40 percent. But it is not obvious that the average non-GSE mortgage will look that bad.

However the market is trading quite a bit worse than that. It is very common to find the AAA strips trading at 80c in the dollar. To lose money on a strip trading at 80c in the dollar you need the losses to be fully 20 percent worse than the above 30 percent of 40 percent scenario.

If 50 percent of the pool defaults and you have a loss given default of 50 percent then you STILL make a profit buying the AAA strip at 80c in the dollar. [Ok – the technically minded will tell you that some of your loot could go to junior strips. But offsetting that you get a high yield in the early periods.]

The meaning of an 80c AAA strip is clear. The market is implying an absolute debacle – something beyond the scope of the really bearish (including me) to contemplate.

I do not think it will happen. I don’t know anyone else who does.

So why does the market keep pricing the AAA strips at 80c? Well I explain in the first post – but it really comes down to “you can’t borrow to buy this paper any more”. The deleveraging will stop when the assets are patently attractive to unlevered buyers – and they are not there yet.

Meanwhile the market seems to imply something that looks insane to me. The market is implying that more than 50 percent of diversified mortgages (not originally deliberately subprime – but not GSE suitable) will default at a severity greater than 50 percent.

So what is the implication of mark-to-market accounting?

Above I argue that the market is insane. It’s a dangerous thing to argue – but I argued the market was insane when subprime mortgages were trading at 101c in the dollar because they had high yields. And I will argue it now when securitisation paper is trading as if losses across the whole US will be greater than 50 percent of 50 percent.

It was insane (but technically correct) for investment banks to mark their book to market when the price of a subprime mortgage was 101. If you believed those accounts you would take on lots of risk and declare immediate profits. Anyone who managed their business as if that was a permanent state is now bankrupt.

It is similarly insane (but technically correct) for anyone subject to fair value accounting to mark a levered book to the current implied market default rate for mortgages.

The market was wrong then and it is wrong now. But fair value accounting required mark to insanity then and similarly requires it now.

If you do mark to the current insanity and you have a lot of mortgages your accounts will show you as breathtakingly insolvent.

So what do you do? Reclassify the assets as level three and mark them to model. It is technically fraud to do this when the assets can be priced – but no more wrong in my opinion than valuing the subprime mortgage at 101 in the first place.

The most obvious such example is Freddie Mac putting over 150 billion of its assets in the level three bucket. Almost all of those assets have a market. It is just that Freddie Mac (justifiably) doesn’t like the price and so marks-to-something-other-than-fair-value.

But it is not just Freddie Mac who is in this position. Everybody with a substantial list of stressed financial assets is. And everybody marks to model. And the models bear little resemblance to fair value as defined in accounting standards.

But if the model makes reasonable probability weighted estimates of the present value of what you will receive in cash on the asset then I can live with the mark-to-model (fraudulent as it is). In fact I will defend it – hence the title of this post.

Unfortunately there is a problem. Once you have decided to commit fraud (as I believe almost every financial institution has) then you might find yourself “in for a penny, in for a pound”. Having decided that you do not want to mark to “fair value” it is not far to decide that you want to mark to total myth. For instance you might (rationally) decide that it is not sensible to mark the mortgage to a 50 percent default and 50 percent severity. But that is no excuse to marking it to a 3 percent default and 15 percent severity. In for a penny…

The level three decision made by Freddie Mac is fraud. They can find a fair arms length value and they chose not to do so. But it is a reasonable fraud – and it is in the interests of Freddie Mac, its shareholders, probably its creditors and certainly its regulators. The accountants are happy to sign off on it too. I wish I knew what reality was and how far from reality Freddie’s models are. I don’t – and so I will not be buying Freddie Mac stock.

Freddie’s fraud is the same fraud committed by everyone who has a substantial amount of financial assets to mark to models.

So how to assess a financial institution?

Having decided that almost all financial institutions are fraudulent the question for a long or a short-seller is not is there fraud or not (as per my European banking analyst). The question is “how much fraud – and just how bad is the book really”.

This is a real problem. Whilst I do not think that the mortgages will have a worse than 50 of 50 outcome – I do believe that it will be worse than 30 of 40 in a wide range of circumstances.

Every one (reasonably) decided to ignore the illiquid markets. Here are a couple of places where they have degenerated into unreasonable myth:

  • Barclays manages to produce almost no losing trading days.
  • Royal Bank of Scotland has 10 billion dollars of second lien mortgages in the Midwest on which their provisions imply an almost zero loss rate and where the secondary market is way less than 40c in the dollar and where the house prices have fallen to zero.
  • Barclays had some private equity loans that they originally intended to originate-and-sell. They are stuck with them. They are stretched. The model prices remain in the high 90s where the companies are cash-stretched right now.

I could go on. These are by no means the atypical myths.

  • I crossed the bridge ages ago when I decided that financial institutions mark to things that don’t look like reality at all. (My UK banking analyst friend has not got there yet. That seems to me to be a willing suspension of disbelief.)
  • I crossed the bridge this year when I decided that the fraud was OK. I know my morals have slipped. But I will say it again. Some fraud is fair and reasonable.
  • I have also decided that you need to grade the fraud from “white lie” to “mark to hope” to “mark a myth so far from obvious reality it is comic”.

David Einhorn in his latest book demonstrates Allied Capital does a lot of marking to a myth so far from reality it is comic. Reading his book is great fun (though living it would have been somewhat rougher).

Unfortunately I think that mark to comic myth is becoming the norm for UK banks as well. The main problem is that the UK banks are much more levered than Allied Capital. Mark-to-myth at 40-50 times leverage is a recipe for tragedy.


Post note: In this post I say a few things that are dangerous - and which I do not believe except within the narrow context of other financial institutions (not me). For instance I say "some fraud is fair and reasoable". I wish never to be quoted out of context.

Tuesday, June 17, 2008

Barclays in denial

There is a lovely article in the Daily Telegraph about Barclays being in denial about the size of the losses that it needs to take.

One thing that caught my eye was the following:

It has even been suggested that Barclays chose not to offload its Alliance Boots debt, when others in the banking syndicate took a 10 per cent valuation cut to get the assets off their books, because Varley and Diamond wanted to protect the minimal writedowns on leverage loans.

Well you might say that. I couldn't possibly comment.

Anybody looked lately at their consumer lender exposure in Japan? I couldn't possibly comment.

How about just the almost total absence of losing trading days in the investment bank. I couldn't possibly comment.

Anyone you know carried an 800 billion pound investment bank portfolio and not lost money on at least some days... I couldn't possibly comment.

How about the LBO exposures. Well apart from Boots I cannot possibly comment.

Friday, June 13, 2008

Short post today: Barclays and fraudulent hedge funds

This is just a short post - to tie in some loose ends I have.

I wrote yesterday about Barclays Global Capital.

I have written twice about a fraudulent hedge fund (New World Capital management) - see here and here.

Barclays has developed quite a business marketing hedge funds. They compile a ranking of hedge funds. Here is the current ranking of their currency funds.

Now here is my sting: at one stage New World Capital Mangagement was ranked Number One on Barclays Hedge fund rankings.

Thursday, June 12, 2008

Barclays - strange, stranger and truly opaque

Barclays is the financial institution in the world that most scares me. Indeed it petrifies me. It is huge (currently the second biggest institution in the world and substantially larger than Citigroup). It is highly levered. And it is in all the places you don’t want to be at the moment.

Barclays may be “too big to fail” but it is also probably “too big to bail out”.

You will have to forgive me a long post but this is one of the most important stories in the world today – and I am groping a little in the dark. Wall Street is currently (correctly) obsessed by Lehman Brothers – but they should be similarly obsessed by Barclays Global Capital. Barcap is a far more interesting and important beast. Moreover the standard hypothesis these days is that Barclays will buy Lehman. See this press report for an example.

If you follow Lehman you should also follow this – just to see how strange this hypothesis is.

I posted my old notes on Northern Rock to warm you up for this. If you haven’t read them read them before reading this.

What went wrong in UK Banking!

UK banking has been a true disaster. Far worse than the US – or even than the much maligned UBS. The stock price of Royal Bank of Scotland for instance has been much worse than UBS. The stock price of Barclays is not quite as bad – but is still ugly. That is despite the UK banks not declaring substantial losses. Quite strange.

The origins of this disaster lie in the collapse of UK mortgage margins. UK mortgage margins have fallen and fallen. The different banks had different responses to this fall. Halifax – which was originally a pure mortgage bank – made the most sensible call of all – which was to buy Bank of Scotland. It hasn’t saved them entirely from the crunch – but the shareholders of Halifax have done far better with BOS than they would have done alone. RBS purchased lots of businesses in the US (with which came a subprime problem). One kind way of describing their behaviour was that they were last seen standing by the side of the road with a sign that read “anywhere but here”. Abbey National gave up and sold itself to Santander. Northern Rock decided to make up the margin collapse with more volume – and we know where that got them.

Barclays decided to become a debt trading investment house. About half of its profits now come from the sort of activity that Lehman does.

This market is hostile to pure debt trading investment houses. Barcap should be having a truly awful time. But the remarkably the management are quite upbeat - declaring their investment banking division profitable - this quote headlining the 15 May trading statement (my emphasis):

“Our 2008 performance continues to benefit from the diversification of our business in recent years. In Global Retail and Commercial Banking, our UK businesses performed well. There was very strong profit growth in Barclaycard and we continued to expand our international businesses rapidly. Our Investment Banking and Investment Management businesses were profitable in challenging market conditions.

Pay up for talent

Barclays did not buy an investment bank. There were persistent rumours that they would buy Lehman – but it never happened. The way that they built the bank was to steal whole teams from lots of investment banks – offering what investment bankers respond best to – lots of filthy lucre.

One year they put on a thousand staff at over 250 thousand pounds average salary. That seemed like an aggressive hiring spree to me. The next year they doubled it and I think (but cannot confirm) they continued to expand on this pace. This is a lot of cost base to add to a retail bank with declining margins.

I know they offered guaranteed bonuses – so when they slow this beast down the staff costs do not go away.

Barclays has some good businesses – notably the i-shares that are so beloved of hedge funds. But most of what they do is just looks like a standard debt driven investment bank.

Steroids got nothing on this growth – lets look at gross derivative exposures

Having employed all these people and told them to trade. Unsurprisingly they did. Now I am just going to extract a few things from the annual reports. Here is the derivatives exposure from the 2007 annual:

I encourage you to click for detail.

These numbers are as they seem. The total gross derivative exposure is 29 trillion pounds. I deal with banks – but I am not used to dealing in trillions of pounds. I don’t think anyone is.

The gross credit swaps are 2.4 trillion pounds – but mysteriously the fair values (both assets and liabilities) are low. Only the fair values go in the consolidated balance sheet so if you were to mark these like some people do the balance sheet would be much larger. (There is mismarking in someones book - but it may not be Barclays).

The CDS are up from a mere 1.2 trillion at year end 2006.

The scale of the growth is best seen by looking at the same disclosure in say the 2003 table (snipped from the 2004 annual report):

Again I encourage you to click for more detail.

In four years our derivative exposure (total face) has gone from 5.9 trillion pounds to 29.2 trillion pounds. Our credit derivative exposures have gone from 43 billion pounds to 2.4 trillion pounds. [I keep needing to watch myself when I type this. I am not use to this many zeros – and I deal in Japanese banks which account in yen.] Anyway this is about 50% annualised growth - reflective of the great Barcap hiring spree.

It is not just the derivatives that they grew. The on balance sheet exposures grew to astronomical size too. Here is the summary from the Barclays annual report of Barcap.


Lets stress how weird this is. You have 3.8 billion pounds of “trading income” and only 42 million pounds of “value at risk”. The balance sheet however – and this is ON BALANCE SHEET exposure is a mere 840 billion pounds. That is about the same size as the whole of Citigroup! In the income statement they took a net 795 million pounds of charges against US subprime exposure. That is 19 times their value at risk.

Oh, and you got all this income with a trading team you hired with guaranteed bonuses into the most crazy-for-talent market that has ever happened. When I saw the bonuses some of my friends were being promised - well I wondered why I wasn't going to Barclays.

They were pretty good traders all up too. Unlike anything I do they made money almost daily. Below is the value at risk over 2005-2006 with the number of positive and negative trading days.



I love this - almost EVERY day they made money.

It was a little rougher in 2007 - as the 2007 annual makes clear

Analysis of trading revenue

The histograms show the distribution of daily trading revenue for Barclays Capital in 2007 and 2006. Revenue includes net trading income, net interest income and net fees and commissions relating to primary trading. The average daily revenue in 2007 was £26.2m (2006: £22.0m) and there were 224 positive revenue days out of 253 (2006: 243 out of 252). The number of negative revenue days increased in 2007 largely as a result of volatile markets in the second half of the year. The number of large positive revenue days also increased but these were spread across the year
Oh well - in bad times you get some losing days at Barclays.

Of course it all depends on how you mark the exposures. Barclays held - and continues to hold lots of nasty stuff. Their marks on the super-senior CDOs are implying only a fraction of the problems at Ambac or AIG. How do I put it? When is it mark to model and when is it mark to myth?

They put out a interim trading report. Its here. You look at the marks - and see if they make sense to you. The statement is here (warning pdf).

They got the true subprime thing happening here. They own Equifirst - a true subprime lender. Or at least it was a true subprime lender - it now does FHA loans and the like. They purchased in March 2007 when it was early in distress. They got a few billion pounds of loans with the acqusition that they meant to securitise if the market reopened. Oops.

They got the lot. Just read the appendix to the trading statement. And compare to AIG.

I got much more on this thing. But this is a blog and meant to be light hearted. Enjoy.

John

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