Jeremy Warner's Outlook: Barclays reassures, but what of the future?

No getting away from Rock exposure; S&N bid battle: still plenty to play for
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The Independent Online

You'll be relieved to know that there are no black holes at Barclays, just as the management had previously intimated. Despite £1.3bn of charges in respect of credit, mortgage and leveraged finance writedowns, revenue and pre-tax profits in the 10 months to the end of October were at record levels.

Perhaps surprisingly, Barclays Capital seems to have handled the credit crisis more cleverly than many of its American investment banking counterparts, having reduced its direct exposure to the sub-prime mortgage market and adroitly hedged itself against other difficult positions.

The £190m writedown taken against the bank's £7.3bn exposure to leveraged finance may be on the optimistic side, but John Varley, the chief executive, is insistent that these are acceptable credit risks which Barclays is entirely comfortable with having on its balance sheet. No need, then, to take any more of a haircut.

So if there is nothing fundamentally wrong, and the air has been cleared after all the doom-laden speculation of recent weeks, how come the shares didn't bounce more convincingly? The answer lies in that unnerving ability of markets always to find something else to worry about. OK, so the immediate damage may not be as bad as expected, but what is the credit crisis going to do to banking profits further out?

As it happens, most banking analysts seem to have stuck with previous forecasts of rising profits for both next year and the year after. These projections will loosely be based around guidance from management. Are bankers simply in denial? There is at least some grounding for their optimism. Whereas some product areas are going to see a collapse in volumes as a result of the credit crunch, these areas of weakness are being compensated for by growth elsewhere. Mortgage-backed securities and private equity loans may be as dead as a dodo, but currencies, commodities and equities are hot.

With bank shares more than 30 per cent off their peaks, the markets are displaying a high degree of scepticism about the deliverability of these buoyant earnings projections. Mr Varley may have convinced us that there are no black holes, but he's not yet provided the certainty of future outlook that would prompt investors to pile back in. Nor can he.

No getting away from Rock exposure

Just how exposed is the taxpayer to the Northern Rock debacle? In the Commons this week, the Prime Minister gave the impression of no exposure whatsoever, as the roughly £20bn of public money extended through the Bank of England was "secured lending" against Northern Rock assets.

Throughout the crisis, Alistair Darling, the Chancellor, has similarly attempted to reassure against any cost to the public purse. The Bank of England wouldn't have lent if it had thought Northern Rock was insolvent. The money was only to tide the company over a temporary liquidity problem.

We'll ignore, for the time being, that one of the primary definitions of insolvency is inability to pay liabilities as they fall due, which surely would be the case at Northern Rock if it didn't have an apparently open-ended facility from the Bank of England.

Yet even brushing aside this uncomfortable little truism, the Government's money is plainly very substantially exposed. If the company was liquidated tomorrow, the taxpayer would be highly unlikely to get all his money back.

Here's a rough guide as to why. The loan book is reportedly worth around £100bn, more than enough, you would have thought, to cover the Bank's £20bn and the separate Treasury guarantee of about £18bn of retail deposits. Unfortunately, around half the loan book has already been securitised. The vehicle through which this was done, a Channel Islands-based charity called Granite, has first call on these assets.

Some £13bn of the Bank of England facility is pledged against specific, apparently good-quality collateral, though even here the Bank of England had to relax the rules it normally applies to lend so much. Some of this collateral is not as high quality as the Bank would normally demand.

For the £11bn balance, there is no specific collateral at all. Rather, the money is secured against the assets of the company as a whole once prior claims have been satisfied. The Bank, by the way, only acts as agent on the Treasury's behalf for this money. The Treasury has also separately indemnified the Bank against the lender-of-last-resort facility.

Yet in theory, there should be enough in the Northern Rock kitty to cover the Treasury commitment. After Granite has had its share of the cake, there's £50bn of assets left to cover the Government's £38bn exposure. The trouble is that in these markets nobody believes that mortgage assets, even high-quality ones of the type Northern Rock claims ownership of, could be sold for anything like their face value.

Any notion that the Government can somehow wriggle off the hook by simply triggering a receivership is therefore complete fantasy. The Treasury has got itself in much deeper than it ever anticipated, and, recklessly or otherwise, has indeed exposed the taxpayer to the possibility of very serious losses.

Its best hope of getting the money back is to continue financing the company until more orderly credit conditions return, and the Bank of England's loans can be refinanced in the markets. As the sales prospectus has spelt out, this may take many years. Bringing in Luqman Arnold, the former Abbey National boss, to manage it all out looks by far the best of the available options.

In the meantime, ministers will have to persuade the European Commission to roll over what self-evidently amounts to state aid, when the deadline for such assistance expires in February, into "reconstruction aid". Given the way the UK Government has lectured its European counterparts on the meaningless nature of this distinction, it promises to be more than a little embarrassing.

S&N bid battle: still plenty to play for

Carlsberg don't do bid battles, but if they did ... If they did, they might have come up with a rather better price for Scottish & Newcastle than the 750p a share offered in conjunction with Heineken yesterday. This is only 4 per cent more than the previous offer, and is still not enough to get a foot in the door.

As a multiple of ebitda, the price compares favourably to that paid by S&N for most of its acquisitions, including the prize asset of Baltic Beverages Holding (BBH), which it owns jointly with Carlsberg. Yet the valuation doesn't properly reflect either S&N's scarcity value – S&N is the only brewer of such size that it is in practice possible to bid for – or the strategic value of its position through BBH in the fast growing Russian beer market.

S&N says it would love to tell us all about the stellar prospects of this business but is prevented by the shareholder agreement it has with Carlsberg. If S&N can say nothing, Graham Mackay, chief executive of SABMiller, is under no such constraints.

Yesterday he described Russia, where he is fourth in the market against BBH's premier position, as one of the most exciting beer markets in the world. He also seemed to row back a bit on his previous description of western Europe as " singularly unattractive". Might he counter bid? Mr Mackay is as canny as they come. But I doubt he yet knows whether he's going to pitch in.

Were it not for the joint venture agreement with Carlsberg over BBH, he might well. This enormously complicates matters. Only one thing seems clear. The status quo, particularly with regard to the Russian assets, is unsustainable. S&N shareholders find themselves in the happy position of being at the centre of this consolidation puzzle, and the last great opportunity of its type. Yesterday's 750p-a-share bid is unlikely to mark the end-game.