Barclays Shares Rally on Writedowns

Editor's note: After Barclays Chairman Marcus Agius and Chief Executive John Varley wrote an open letter in a bid to reassure investors, the bank's shares skyrocketed by as much as 60% on Jan. 26. Barclays announced $11.3 billion in writedowns and noted that annual profits will be more than $7.4 billion.

To see the extent to which panic has gripped investors in British banks, just take a look at what is happening to the share price of Barclays (BCS), Britain's third-largest bank. Barclays' shares are down 50% since Jan. 16, when the bank rushed out a preliminary earnings estimate to try to calm the markets. The markets worry that Barclays is not taking deep enough writedowns on bad assets and that with other banks such as the Royal Bank of Scotland (RBS) reporting monster losses and falling under government control, Barclays cannot be far behind.

Trying to head off pressure on its share price, Barclays rushed out a statement on Jan. 16 saying that the bank expects to report results "well ahead" of analysts' consensus estimate of £5.3 billion ($7.3 billion) in earnings for 2008. That number, the statement said, would reflect "all costs, impairment, and market valuations." Results are scheduled to be released Feb. 17, but the date may be moved up.

Yet Barclays' revelations that it would be making a profit hasn't done much to help the stock price, which has continued to fall. Barclays' share price has fallen almost 90% over the last 52 weeks, bringing its market capitalization down to a scrawny $6.82 billion, less than the earnings it is promising for 2008.

Investors are worried about two main issues. First, they suspect that Barclays, which has taken lower write-offs than some other banks, is not taking steep enough hits on the loans and risky instruments on its books. Investors also worry that Barclays, which spurned the British government's first-round bailout last year, will eventually have to acknowledge huge losses and raise more capital, thus diluting shareholders. Investors have already suffered dilution in the stock thanks to Barclays' earlier efforts to raise capital from Gulf investors and others. Individuals and institutions in the Gulf now own 31.9% of Barclays.

Barclays President Frustrated

Adding to the near-panic about Barclays is a stipulation that gives a member of the Abu Dhabi royal family and two Qatari investment funds, which together pumped about $7 billion into Barclays last October—when Barclays' share price was nearly three times what it is today—the right to reset those investments to the market price if Barclays issues new shares before June 30, 2009. That potentially could give these investors control of the British bank. There has been speculation in the British press that this clause, which Barclays says is not unusual in such circumstances, would prevent Barclays from obtaining a capital injection from the British government, if it needed one.

Barclays responds that it is well-capitalized. It also says nothing prevents it from participating in upcoming British government schemes to help the banking sector, such as one under discussion that, for a fee, would insure the banks against losses on bad assets. Barclays CEO John Varley suggested on Jan. 23 that if necessary, Barclays would pay such a fee in cash, not shares.

In a phone conversation, Bob Diamond, Barclays' president, did little to hide his frustration with the cratering of Barclays' stock and the tumult in the markets. "We are in an environment where no one wants to believe anything," he said. "People look at our positive results—which have included substantial writedowns—and say something must be wrong. I find it very frustrating that people think the prices at which we've marked our assets aren't right. We have been through a number of reporting periods with fully audited financials, with close supervision by the regulators and the FSA (the British equivalent to the SEC), as well as due diligence by sponsors of our capital raising. Our writedowns have been entirely appropriate, and have been validated by substantial sales of assets at the prices we marked them down at during the course of 2008, as disclosed in our results announcements."

Until the credit markets collapsed, Diamond had been one of the stars of the City of London. He turned stodgy, struggling Barclays into a growth business largely thanks to Barclays Capital, the investment bank he created. Barclays Capital had an unusual business model. It eschewed the usual investment banking businesses, such as M&A and equity raising, in favor of innovative credit products, commodities, and foreign exchange, which took off in the 21st century. Now, of course, credit is at the epicenter of the crisis in the financial industry. But, Diamond contends, several of these businesses are still doing well. Diamond also presides over Barclays Global Investors, a leading asset management outfit based in San Francisco.

Wise to Acquire a Piece of Lehman?

Along with many seasoned observers, Diamond has been surprised by the intensity and the duration of the credit crisis. But he has not let it paralyze him. He believes the crisis is providing a window for Barclays and other strong financial institutions to increase their market share and snap up weaker competitors. Last fall, Barclays bought Lehman Brothers' North American operations out of bankruptcy. An American, he is now spending more time in the U.S. than in London, his longtime base. Diamond got Lehman cheap—for just $1.6 billion. But observers still wonder whether expanding in these uncertain times was wise. "They are very aggressive," says a European bank CEO, referring to Barclays. He questioned the wisdom of adding new risk at a time when the world economy "is heading into uncharted waters."

Analysts were mildly pleased by Barclays' pre-earnings announcement. "This scuppers any prospect that the group recorded a substantial loss in the last two months of 2008," says a UBS (UBS) note. But analysts were puzzled by Barclays' statement that its yearend equity Tier One capital ratio, a key measure of capital strength, would be 6.5. Analysts had expected a higher ratio. UBS analysts figure this means that Barclays' risk-weighted assets increased by 17% in the second half of 2008, which is higher than expected and a possible sign that the assets on its balance sheet are deteriorating. The coming months will reveal whether Diamond and Varley have made the right calls—though with shareholders so damaged already, it may not matter.

Before it's here, it's on the Bloomberg Terminal.