Jeremy Warner: Has anything really changed in banking as Barclays exits BGI?
Saturday 13 June 2009
Outlook: Would Barclays be disposing of Barclays Global Investors (BGI) at all, let alone at this stage in the cycle, were it not for the banking crisis and the need to raise more capital? Probably not, John Varley, the Barclays chief executive, admits candidly.
But needs must, and in the circumstances swopping a 100 per cent interest in BGI, Barclays' giant investment management arm, for a 20 per cent economic interest in BlackRock and £4bn in cash, looks a good outcome from Barclays' point of view.
The deal is accompanied by some wearingly familiar trappings. Barclays has to lend BlackRock some of the money it needs to buy BGI, it has to keep some of BGI's loss-making structured credit vehicles, and Bob Diamond, head of BarCap, as well as several of BGI's leading lights make a personal killing. Don't you just love these investment bankers? Come rain or shine, they always manage to come out on top.
All that, combined with the realisation that Barclays is losing one of its most stable sources of earnings, leaving the rump looking a good sight more volatile, contributed to a faintly negative reaction in the share price yesterday. Even so, the positives seem broadly to outweigh the negatives.
At five times revenues and 12 times Ebitda, the valuation is a good one, and there may actually be some benefits to Barclays in terms of cross selling with BGI now at arms length to the rest of the bank, rather than wholly owned. Barclays also exits with a massive £5.3bn gain on its original investment. Barclays would obviously have done better to have sold a couple of years ago at the top of the market, rather than now, with shares still deep in the doldrums. Even so, it has managed an excellent rate of return.
Yet the real bonus is that it enables Barclays to play catch up on its capital ratios with other banks without having to go back to investors for more equity. Mr Varley is still notably cautious about the outlook. He accepts that the worst of the banking crisis is behind us, but thinks that the worst of the economic downturn is still to come. He regards recent signs of a return to growth in the UK economy as no more than a temporary and technical blip caused by the end of the inventory adjustment.
If that's true, then Barclays still needs all the capital it can get. For the time being at least, there's very little chance of the capital derived from selling BGI going into a war chest for acquisitions or balance sheet expansion. Instead it will be left to lie fallow against the still real possibility of storms to come.
This kind of mindset, which is by no means exclusive to Barclays but is pretty much universally shared among bankers, is another reason for remaining cautious about the economic outlook. Banks still don't have sufficient capital to make them confident enough to start expanding their lending again. To the contrary, most of them are still set on balance sheet reduction.
For instance, the Royal Bank of Scotland recovery plan involves reducing the balance sheet by around a quarter over time, mainly through runoff. Much of this credit reduction is overseas, or in investment banking activities, yet it is one hell of an amputation that's going on given that the RBS balance sheet is worth around one-and-a-half times Britain's entire annual GDP.
If Mr Varley used the renewed strength in his capital ratios to take on more business, it would be earnings accretive in the short term. To leave the capital on deposit, as intended will, on the other hand, be earnings dilutive. Yet this is as much what the Government and regulators demand as that the banks get the wheels of credit moving again by lending more to business and home owners.
There is no obvious way of squaring this giant contradiction at the heart of public policy towards the banks. On the one hand, the authorities want the banks to lend more, even though with a recession still in full swing there could hardly be a more high risk time to turn the taps of credit to full on, while on the other they want banks to be safer, to store up capital for a rainy day, and to restore prudent lending standards.
The Government cannot have it both ways. Given that capital is still scarce, there is little doubt about the outcome – the second priority will triumph. Safer banking is going to come at a cost and inevitably it is customers who will be made to pay the price. Capital has a cost, which means that now banks are required to hold more of it, borrowing from banks will become correspondingly more expensive. Call this a necessary repricing of risk if you like, but after the years of plenty, many debtors think of it as just a straight rip off.
We are switching from a world in which it was easy and cheap to borrow to one in which it is harder and more expensive. This may be a wholly necessary adjustment, but few are prepared to accept its consequences.
Hence the chorus of complaint from business and mortgage holders about cripplingly higher charges every time they come to refinance. Relative to base rate, banks are slowly but surely forcing up the cost of borrowing. From a structural point of view, this may well be a healthy development. Per capita indebtedness in Britain is higher than anywhere else in the world. The savings rate is also the lowest. To bring about a more balanced economy, in which investment plays as big a role as consumption, the relative attractions of borrowing and saving must reverse.
Over the past 20 years, old fashioned virtues of thrift have become perversely irrelevant. It's been a mug's game to save and you would have been a fool not to borrow. The real winners have been those who have leveraged themselves to the hilt.
Ordinary people have been able to do this through housing. The high priests of finance have done it through structured products and leveraged buyouts. Requiring banks to hold more capital relative to lending will in itself help to reverse this relationship. For many, the adjustment is going to be a difficult and painful one.
A number of other generalisations can be made about the present state of banking off the back of the Barclays deal. Profits are rising again and bonuses are back. It's as if the banking crisis of the past two years never happened. While public fury is focused on the scandal of MPs' expenses, bankers have been quietly returning to business as usual, in so far as their own pay and many of their practices are concerned in any case.
Despite having plunged the world economy into chaos, despite the bailouts and the oodles of taxpayers' money poured into overstretched balance sheets, bankers are beginning again where they left off. The Barclays transaction alone involves an advisory fees bonanza. Salvaging the banking system has similarly involved massive fees. Corporate refinancing has paid huge dividends in the City.
It is almost as if bankers created the crisis in order to generate new sources of income from cleaning up the mess. The vitriolic public opprobrium reserved for bankers has been like water off a duck's back. There's little sign of contrition, still less a change in modus operandi.
Some banks have also been particularly aggressive in using the present distress to force their services and fees onto clients in no position to resist because of the scarcity of credit. On any refinancing, particularly those involving a breach of covenants, new loan agreements come riddled with conditions and fees. Banks have shamelessly seized the opportunity to "imprison" their clients.
These things will not be quickly forgotten, and even as the banking system recovers from its near death experience, do not bode well for the long term future of this industry.
I've wandered a long way from the initial subject of this column – the Barclays disposal – but the sight of Mr Diamond profiting so handsomely from an asset sale designed to shore up the bank's balance sheet and ensure that the bank is once more safe for its customers makes it look as if senior bankers have learned nothing from the crisis they created.
Never mind that Mr Diamond played it by the book – to address the conflict of interest he stayed out of the decision and the negotiations. Nevermind too that unlike others, Barclays hasn't taken a penny of taxpayers' money. Bankers seem to operate in a bubble entirely divorced from the lives and concerns of ordinary people.
Perhaps things will change in time, and, as I have argued, there are important structural shifts now occurring within banks which will have important consequences – cultural as well as practical – for the long term availability and cost of credit. These aspects of banking will not be returning to normal any time soon. Yet bankers seem to have lost precious few other of their bad habits. Hey ho.
Diving in at the deep end is no excuse for shirking the style stakes
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