Fitch: Barclays' Capital Increase Removes Uncertainty; Q2 Hurt by More Conduct Costs

Wed Jul 31, 2013 10:02am EDT

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(The following statement was released by the rating agency) MILAN/LONDON, July 31 (Fitch) Fitch Ratings says that Barclays plc's (A/Stable/F1/a) GBP5.8bn capital increase and additional capital raising/release measures remove any uncertainty over the bank's previous plan to reach its target capitalisation organically. The capital increase will bring the bank's 'look-through' Basel III common equity Tier 1 (CET1) ratio into line with similarly rated global trading and universal bank peers (9.3% pro-forma at end-H113 versus 8.1% actual). In May, Fitch noted that it expected leverage to decline as Basel III leverage requirements are introduced (see 'Fitch Affirms Barclays at 'A'; Outlook Stable' dated 16 May 2013). These measures in essence represent an acceleration of that timeframe and have no immediate impact on Barclays' ratings. The capital raising measures were largely caused by a GBP12.8bn shortfall relative to a 3% leverage target identified under a capital assessment exercise on the major UK banks by the UK Prudential Regulation Authority (PRA) in H113. The PRA exercise assessed banks' capitalisation on both a risk-weighted basis and an un-weighted basis. It conservatively required incremental deductions against 'end point' CET1 capital i) for expected future losses on certain portfolios on a three-year basis and ii) for potentially uncovered conduct costs (albeit not for less quantifiable possible future litigation costs, eg in respect of LIBOR). Barclays' capital raising measures, which also include a reduction in on- and off-balance sheet exposure, are needed to enable the group to reach the PRA's un-weighted 3% leverage hurdle by mid-2014. They mean the group now expects to meet its own 10.5% target Basel III CET1 ratio, which is now defined on a 'look-through' basis, in early 2015. The planned issuance of up to GBP2bn additional Tier 1 (AT1) instruments would add a further buffer to the group's capital structure. The instruments are to have a 7% trigger in terms of the 'look-through' Basel III CET1 ratio rather than the transitional ratio used in the bank's existing Tier 2 contingent capital notes. This means that during the Basel III transitional phase, the trigger on the new notes would be hit before the trigger in the group's existing Tier 2 contingent capital notes. Non-performance risk on the new AT1 instruments will in any case be higher than on the existing Tier 2 contingent capital notes because of their fully flexible coupons. Barclays' results for H113 were hit hard by sizeable further provisions for claims relating to payment protection insurance (PPI) redress and for the sale of interest rate derivative products, which amounted to GBP2bn. These and GBP640m costs associated with the bank's reorganisation programme meant statutory pre-tax earnings (excluding a small gain on own credit) were weak, equivalent to a return on equity of less than 3%. Adjusting for these items and for a one-off gain in H112, pre-tax profit of GBP4.2bn represented a more modest decline of 2.5% yoy. This reflected relatively resilient revenue (down 3% yoy on an adjusted basis), a 4% reduction in operating expenses excluding the reorganisation costs and a small decline in loan impairment charges. Q213 pre-tax profit adjusted for the items above stood at GBP1.9bn, a 16% qoq decline and virtually flat yoy. In Q213, all business divisions, with the exception of UK Retail and Business Banking (RBB), European RBB and Wealth and Investment Management (WIM), reported a yoy improvement in pre-tax profit adjusted for own credit and PPI and derivatives provisions. Compared with Q113, all business divisions reported increased adjusted pre-tax profit with the exception of the investment bank and WIM. As expected, Q213 net revenue in the investment bank declined qoq following a seasonally strong Q113 and adjusted pre-tax profit fell 18% qoq. The quarterly decline in net revenue from FICC at 37% was more pronounced than at US peers, and net revenue also declined yoy, by 22% as the group's rates, currency and commodities businesses and its credit trading generated less earnings. Equities and prime services performed well with net revenue improving qoq (by 17%) and yoy (34%). Equities trading benefited from good performance in cash equities and equity derivatives, and prime services saw market share increases. Advisory and capital markets business improved slightly yoy in Q213 but saw a small seasonal qoq decline of 5%. Barclays investment bank continues to report good efficiency with a 58% cost/income ratio excluding the reorganisation costs in H113. UK RBB showed a solid operating performance with pre-tax profit adjusted for PPI redress provision increasing by 11% qoq but declining 7% yoy. As a result of the PPI redress provision the division reported a GBP28m pre-tax loss for H113, but this legacy should now be drawing to a close and the bank expects that any additional PPI charges should be small. Net revenue in the division remained broadly flat in H113 as continued pressure on the net interest margin was compensated by loan growth. Loan impairment charges in UK RBB increased 46% yoy but remained manageable at GBP178m in H113. Corporate banking pre-tax profit excluding the GBP650m provision for redress related to the sale of interest rate derivative products improved 29% in H113 as loan impairment charges fell and revenue remained resilient as earnings in the UK compensated for a decline in the bank's European businesses. Europe RBB reported a GBP709m pre-tax loss in H113, which included a GBP356m expense to restructure the operations. Income in the division continued to decline in H113 as business volumes fell in line with the bank's strategy to reduce its operations in the region. Loan impairment charges increased 14% yoy, but Fitch expects these to remain manageable as the loan loss rate in H113 remained moderate at 70bp. Africa RBB reported a 16% increase in adjusted pre-tax profit to GBP212m, mainly because of lower loan impairment charges, despite reported net revenue falling as a result of currency movements. Barclaycard, the group's credit card business, saw a further rise in pre-tax profit adjusted for PPI redress provisions, which reached GBP775m in H113, up 3% yoy. However, the division was hit hard by an additional GBP690m PPI redress provision, meaning statutory pre-tax profit fell by 89% to GBP85m. Fitch expects the division to continue to generate good earnings as loan balances increase. Despite a reduction in the group's liquidity pool in H113 to GBP138bn at end-June 2013 (2012: GBP150bn), Fitch considers Barclays' liquidity sound. The proportion of cash and deposits with central banks and government bonds in the pool declined but still accounted for 85%. The bank plans to reduce its liquidity pool further to between GBP110bn-GBP130bn and to reduce the proportion of cash and deposits with central banks further to about 45% of the total pool. Fitch considers liquidity at this level sound given that liquid assets cover wholesale funding due in less than one year (GBP93bn) by 148%. Sound liquidity is also reflected in Barclays' estimated 111% Basel III liquidity coverage ratio and the 105% Basel III net stable funding ratio, although these will see a moderate decline as the bank reduces its excess liquidity. Contact: Christian Scarafia Senior Director +39 02 87 90 87 212 Fitch Italia S.p.A. V.lo S Maria alla Porta, 1 20123 Milan James Longsdon Managing Director +44 20 3530 1076 Media Relations: Hannah Huntly, London, Tel: +44 20 3530 1153, Email: hannah.huntly@fitchratings.com. Additional information is available on www.fitchratings.com ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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