Taleb and banks

Nassim Taleb has written two very enjoyable books so far. In his book "The Black Swan", he vividly exposed the risk of investing in banks:

...institution makes steady profits over a long time, only to lose everything in a single reversal of fortune. ... If they look conservative, it is because their loans only go bust on rare, very rare, occassions. There is no way to gauge the effectiveness of their lending activity by observing it over a day, a week, a month, or ... even a century! In the summer of 1982, large American banks lost close to all their past earnings (cumulatively), about everything they ever made in the history of American banking - everything. They had all been lending to South and Central American countries that all defaulted at the same time - "an event of an exceptional nature." So it took just one summer to figure out that this was a sucker's business and that all their earnings came from a very risky game. All that while the bankers led everyone, specially themselves, into believing that they were "conservative". They were not conservative; just phenomenally skilled at self-deception by burying the possibility of a large, devastating loss under the rug. In fact, the travesty repeated itself a decade later, with the "risk-conscious" large banks once again under financial strain, many of them near-bankrupt, under the real-estate collapse of the early 1990s in which the now defunct savings and loan industry required a taxpayer-funded bailout of more than half a trillion dollars. The Federal Reserve bank protected them at our expense: when "conservative" bankers make profits, they get the benefits; when they are hurt, we pay the costs.

I read this book in 2007 but did not heed its warning. These "highly improbable" banking disasters seem to be occurring rather frequently in recent decades. With banks so highly leveraged, I suppose this is to be be expected.

By averaging down after the share price fell well below even the lowest prices that Barclays agreed to sell its shares to the Middle Eastern investors, and selling after the recent quadrupling of the share price, I have managed to make a small overall profit. However, it was not worth the tense ride!

Media reports following 2008 results

Reuters 9/2/09

http://uk.reuters.com/article/businessNews/idUKTRE5181X420090209?feedType=nl&feedName=ukmorningdigest

Barclays said it expected 2009 to be "another challenging year" with credit market losses set to shrink but bad debt charges likely to rise as recession takes its toll.

"2009 will be another tough year. In 2008 we've had a crisis in the banking system; the principal issue for 2009 is going to be rapid economic slowdown, in a sense more a familiar but nonetheless (a) pretty brutal slowdown in economic growth all around the world," said Barclays Chief Executive John Varley.

The UK economy was likely to contract by at least 2 percent this year, he said.

Barclays had had a good start to the year with the performance of its Barclays Capital investment bank arm "extremely strong," the group said. It plans to restart paying dividends in the second half of this year.

The bank reported a 2008 pretax profit of 6.1 billion pounds, down from 7.1 billion in 2007 but ahead of an average forecast of 5.8 billion from 13 analysts polled by Reuters Estimates, since new profit guidance was issued on January 26.

Its equity tier 1 ratio was 6.7 percent at the end of the year, up from 5.1 percent a year earlier, which is said gave it a cushion to absorb rising bad debts.

"We do not need more capital," Varley told reporters on a conference call. "These ratios are well ahead of the minimum required by the Financial Services Authority, and create a substantial loss-absorption capability."

Cantos interview 9/2/09: John Varley's comments

www.cantos.com

Well, we need to recognise that the year's only a month old, so I caveat my response by making that qualification. But I am pleased actually with how we've started 2009. We've seen very high levels of customer and client activity in the first month of the year. It's very clear to us, for example, that Barclays Capital is benefiting from the now complete integration of our new Lehman's business, and we've seen good activity levels in Barclays Capital. And similarly across the Global Retail and Commercial Banking businesses the same sort of trends that we were seeing in 2008, where GRCB performed well, are observable in the first weeks of the year.

Citywire 9/2/09

http://www.citywire.co.uk/personal/-/news/markets-companies-and-funds/content.aspx?ID=328824&re=4708&ea=91427

'As you know, we are committed to recommencing dividend payments in the second half of this year and, to be clear, what this means is paying a dividend before the end of 2009 which relates to the current year,' [Varley] said.

Chairman Marcus Agius said the business had remained solidly profitable despite strong headwinds, in what was a very difficult economic environment. He said the bank intended to start paying a dividend again in the second half of 2009.

Varley: 'Although we have been careful over recent years to avoid inappropriate risk concentration in our major loan books in retail and commercial banking, our plans for 2009 assume that impairments will continue to be at a high level.'

Telegraph 9/2/09

http://www.telegraph.co.uk/finance/newsbysector/epic/barc/4571960/Barclays-chief-executive-John-Varley-says-sorry-for-banks-crisis.html

Bob Diamond ...said the scepticism about Barclays' approach to valuing its assets was driven by "uninformed rhetoric". He added: "It is hugely frustrating to hear this noise". Mr Diamond said the acquisition of Lehman was "game changing". The bank had held back from bidding for the whole of Lehman because of the huge overlap with its business in Europe, so when the opportunity arose to buy just the US business it was "almost too good to be true," Mr Diamond said. The deal would enable Barclays to take advantage of major opportunities such as helping governments raise money.

Independent 9/2/09

http://www.independent.co.uk/news/business/news/barclays-scraps-directors-bonuses-1604727.html

Collins Stewart analyst Alex Potter said: "The outlook statement makes for grim reading, alluding to downturns and recessions."

Although Barclays expects an overall decrease in the gross £8.1 billion in writedowns it saw in 2008, it anticipates that impairments as a percentage of its loans could rise to between 1.3 per cent and 1.5 per cent.

Based on 2008's loans and advances of £510 billion, this could imply bad debt charges of more than £7 billion this year.

To trust the management or the markets?

If the management is to be believed, the Barclays share price of about 50p now is very low.  Is the market right in not trusting the management? Only time will tell. For the record, I give below some of the comments by management recently. It will be interesting to look at these a year or so from now.

John Varley's interview on 22 Jan 09 at Cantos

www.cantos.com

...the government was very clear it’s not looking for ordinary equity as a means of satisfying that payment [for insurance of toxic assets]. Or it could be cash. What is our predisposition? Our predisposition would be to pay in cash.

We felt that by saying what we said - that consensus profit before tax for Barclays for calendar year 2008 is £5.3bn and that we expected was to announce a pre-tax profit result well ahead of consensus. The reason for saying that is it would be irreconcilable for our trading performance in the fourth quarter of 2008 to have been very bad for us to have been able to say what we said about our performance relative to consensus. 

...we said two things about our capital ratios in our announcement last Friday. We said that on a pro-forma basis - taking account of the conversion of the mandatory convertible notes that are convertible by the end of June of this year - that our core tier one ratio would be 6.5 percent at the year end and that our tier one ratio would be 9.5 percent at the year end. Now that’s important because in each of those cases those capital ratios are well ahead of the regulatory minimum that had been established by the Financial Services Authority. 

...we have made many statements to the market during the course of 2008. We have raised capital during the course of 2008. But each time we do that not only are there rigorous internal processes – in other words the Risk Committee of the Board and the Accounts Committee of the Board and the Audit Committee of the Board – ensuring that it is satisfied with the rigour with which these numbers are prepared. Not only that. Not only the application of scrutiny and rigour by external auditors, but also of course the application of rigour and scrutiny by sponsors as we have issued capital. So we have an absolutely clear obligation to ensure that we apply the appropriate process to the publication of our numbers. We take that obligation with deadly seriousness. We have a real time obligation to ensure that the numbers that we publish are reliable and our numbers are reliable. 

There’s one last acid test that it is worth referring to as well, which is that the best justification of the realism of the marks is whether when you dispose of assets you dispose of them at the marks. During the course of 2008 we have disposed of substantial amounts of assets and we have disposed of those assets at the marks.

... the tripartite authorities rely on the Financial Services Authority to undertake that scrutiny on their behalf in respect of all banks. We have in Barclays, as other banks do, what is referred to by the Financial Services Authority as a close and continuous relationship which requires us to give full disclosure at all times and, of course, the Financial Services Authority acting on behalf of the tripartite authorities ensure that they understand very intimately what’s going on in terms of the way in which the business is being run and that they have good disclosure and good transparency relating to our balance sheet and again, that’s an obligation that we take with deadly seriousness because if we were not honouring that obligation, believe me we would not be allowed to do business, simple as that.

We are open for business and the best way of judging that is by reference to our activity levels. If I look, for example, at lending to small and medium enterprise businesses, customers who have a business turnover of up to £20m, we’ve increased that lending during the course of 2008 by about 7 percent. If I look at the business start up market, Barclays has never been more active than today. If I look at residential mortgages, another area of important credit provision to the markets, the average of our new lending market share during the period 2005 through 2007 was about 5 percent. What’s the equivalent figure in 2008? It’s well over 25 percent. We are open for business.

The Times of 23 Jan 09

http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5570035.ece

...according to Barclays’ view of the world, RBS was simply an “extreme example” that, along with HBOS, was not genuinely representative of the rest of the banking sector, with HSBC, Barclays and Banco Santander, Abbey’s Spanish owner, in “a different space” from HBOS and RBS. 

The bank notes that its Tier 1 capital ratio, a key measure of financial strength, stands at 9.5 per cent – comfortably higher than the 6 per cent to 7 per cent expected by the Financial Services Authority – while a more generous interpretation of the capital rules could make that look even better.

Mr Varley is expected to stick to the bank’s policy, widely criticised in the market, of not writing down the value of some instruments on its balance sheet “to market” – the price they would reach if sold today – as others have done. However, one analyst said: “Intellectually, Barclays may well be right. But they are in the eye of the storm and it doesn’t matter what the facts are. The market is saying it doesn’t know what the facts are, so it is discounting what is known, just in case.”

The Independent of 23 Jan 09

http://www.independent.co.uk/news/business/news/barclays-will-make-profit-for-2008-insists-varley-1513573.html

Mr Varley said the Financial Services Authority had been in close contact and was comfortable with the bank's disclosures about its balance sheet. "If we were not honouring that obligation, believe me we would not be allowed to do business, simple as that," he said.

The Scotsman of 23 Jan 09

http://thescotsman.scotsman.com/business/Barclays-small-print--could.4906260.jp

Barclays said yesterday that the suggestion of foreign control was "based on the premise that Barclays will need to raise capital before 30 June". It added: "We said in our statement of 16 January that our pro forma tier 1 capital ratio is approximately 9.5 per cent, well ahead of the level required by the Financial Services Authority."

Barclays said the anti-dilution clause in the Mandatory Convertible Notes agreement had been present in other fund raisings of this type and was fully disclosed. The bank added: "This clause has no bearing on Barclays' ability to participate in the package of measures announced by the Tri-partite Authorities on Monday."