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Global Economics

Barclays' Profits Hit by Credit Crunch

The British bank's first-half pretax profits declined by one-third after it took $5.5 billion in credit-related writedowns

The credit crunch continues to take its toll on British banks. On Aug. 7, Barclays (BCS) revealed its first-half pretax profits fell by one-third, to $5.4 billion, after the bank took credit-related writedowns of $5.5 billion. Describing the bank's performance as "acutely disappointing," CEO John Varley all but apologized for the decline in company's share price over the past year: "Our shareholders have had to endure a lot."

Barclays also revealed a sharp rise in bad debts. For the six months ended in June, total bad debts rose by 155% from the previous year, to $4.7 billion, as subprime mortgages and other credit-related investments plunged in value. And the investment bank Barclays Capital, which many analysts expected to fall victim to the credit crunch, posted net losses of $4 billion.

Bad news, but it's hardly the dire figures posted by many of Barcap's rivals such as UBS (UBS) or Merrill Lynch (MER). Although Barcap's profits fell by nearly 70% in the first half, the unit is still profitable, with earnings of more than $1 billion.

Analysts Expected Worse

And with the exception of Barclays Global Investors, the fund management arm that posted a 32% drop in profit, to $517 million, the remainder of businesses at Britain's third-largest bank—from credit cards to retail banking—are doing well (, 11/15/07).

Many analysts had expected Barclay's results to be far worse, reckoning that management has been overly optimistic in valuing its investments. After all, Barclays has not taken the same massive writedowns on rotten U.S. subprime mortgages as many of its rivals on both sides of the Atlantic. In May, the bank wrote off $3.3 billion on the value of complex debt securities, a fraction of that of many of its rivals. At the time, most analysts assumed Barclay's was simply postponing its day of reckoning.

Now with writedowns still much lower than expected, many are wondering if Barclays has really managed to avoid the toxic stuff held by other banks. For instance, Merrill Lynch was forced to sell $6.7 billion worth of collateralized debt obligations (CDOs) for a paltry 22¢ on the dollar. Some analysts believe Barclays is much better positioned. "Barclays' CDOs are of a slightly older vintage than Merrill's," explains Leigh Goodwin, a banks analyst at brokerage Fox-Pitt Kelton in London. "And they [Barclays] have been more successful with hedging."

Bad News Expected from RBS

The relatively decent figures from Barclays are likely to be in sharp contrast to Royal Bank of Scotland (RBS), which announces its first-half results on Aug. 8. If analysts are correct, the world's fifth-largest bank—after its purchase of ABN-Amro—is expected to turn a $10 billion profit for the first six months of 2007 into a potentially $3 billion loss for the same period in 2008. If so, it will be the biggest loss of any British bank and the first for RBS in 40 years.

Blame rising bad loans in both the U.S. and Britain. In April, RBS took a writedown of nearly $12 billion related mainly to U.S. mortgages, credit-related assets, and leveraged loans. At the time, the consumer banking unit of RBS-owned Citizens Financial Group in Providence, which accounts for 15% of the RBS earnings, noted that loan losses rose sharply in its mortgage-brokerage business. And analysts estimate RBS has a further $1.5 billion in sour loans on its books in Britain.

To cope with the rapid deterioration in the value of its assets, RBS has raised capital through the markets and by selling assets. In June, the bank the bank raised $24 billion in a massive rights issue. And more recently, the bank sold its stake in Tesco Personal Finance back to British retailer Tesco (TSCDY) for $1.9 billion.

Questions About Leadership

With shareholders unhappy about the writedowns and that record-breaking rights issue, some suspect that big institutional investors will press for new leadership at RBS. With no prior banking experience, Chairman Tom McKillop, the former CEO of British drugmaker AstraZeneca (AZN), is viewed by some as potentially too inexperienced to lead the bank through its most challenging period to date. And there are even concerns that CEO Fred Goodwin, who orchestrated the nearly $100 billion takeover of Dutch bank ABN-Amro (ABNYY) last year, might also be vulnerable.

Capell is a senior writer in BusinessWeek's London bureau .

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