Barclays master of its destiny as John Varley’s gamble pays off

By Philip Aldrick
Last Updated: 9:24PM GMT 27 Mar 2009

John Varley, Barclays chief executive, should put away his beloved table tennis bat and take up poker.

No UK bank has played a more high-risk game during the financial crisis and Mr Varley has cleaned up. The Financial Services Authority's (FSA) decision on Friday to green-light the lender's capital levels was the banking equivalent to a royal flush. Mr Varley's gamble has paid off.

Barclays is now the master of its own destiny. Unlike Royal Bank of Scotland and Lloyds Banking Group, it will only participate in the Government's toxic debt insurance scheme if the price suits. There will be no B-share issue and no state ownership. As Mr Varley said when he turned down the offer of state capital last October: "We want to protect the right of self-determination." For Britain's embarrassed financial sector, it is a fig leaf of sorts.

It is an outcome few expected as recently as January. The shares hit a low of 47.3p that month and the credibility of the management appeared sunk when the markets ignored mollifying comments from the board. Sceptics said Barclays was simply hoping "to trade through the crisis" by denying what many analysts reckoned was a massive capital shortfall and by adopting questionable accounting procedures that concealed all sorts of toxic sub-prime losses.

Barclays also tore up the rule book on rights issues, going last – after the equity markets had been drained by RBS and HBOS – and angering shareholders by taking money from Middle Eastern governments rather than its own. By contrast, RBS chief executive Sir Fred Goodwin played a straight hand. He adopted conservative accounting practices and was the first out of the blocks with a £12bn fundraising last April. Sir Fred is now public enemy number one and Mr Varley the respectable face of UK banking. As a bluff, there has rarely been one better.

Barclays was not just bluffing, of course. Mr Varley knew he held some strong cards while RBS always had a dead hand. Barclays' big risks are in its investment banking business Barclays Capital, where it took £8bn of gross writedowns in 2008, but its UK arm is relatively robust. RBS and HBOS, now owned by Lloyds, have been crushed in the vice of collapsing credit markets and UK bad debt.

To assess the banks' financial strength, the FSA stress-tested their capital against a UK recession deeper and longer than the 1980s. According to sources, it assumed a near-halving in house prices and over 5pc collapse in GDP from peak to trough. Under such a scenario, the asset classes that suffered most were commercial property and housing. Both RBS and Lloyds, following its acquisition of HBOS, had that in droves.

At Lloyds, lending to property companies totals £89bn and at RBS £62bn, but at Barclays just £5bn. Barclays' mortgage book is also better-looking. Some 16pc of Lloyds' home loans are in negative equity while only 6pc of Barclays' mortgages have a loan-to-value of more than 90pc. The FSA's stress-test played to Barclays' strength because it is less exposed to a downturn in the real economy.

At the same time, state bail-outs came to the rescue of Barclays' credit market assets. The aggressive accounting treatment Barclays took on its leveraged loan portfolio, which allowed it to avoid billions in potential writedowns, was standardised by regulators – vindicating Mr Varley's bold decision and punishing those who had been more prudent. Britain's toxic debt insurance scheme and its US version, the $1 trillion Term Asset-Backed Securities Loan Facility, have since put a floor under falling asset prices.

Concerns about certain credit market exposures remain, but the FSA has deemed that Barclays 6.7pc core tier one capital is enough to meet the FSA's new recommendations that the ratio be above 4pc at the bottom of the cycle. According to analysts, the lender has room to absorb £17bn of losses. "I think there will be more asset market writedowns but they will be lower than last year," Ian Gordon, banks analyst at Exane BNP Paribas, said.

At the same time, Barclays is rebuilding capital internally. The planned sale of its exchange-traded funds business i-Shares is expected to raise £3bn-£4bn of capital and, unlike RBS and Lloyds, the bank is forecast to be profitable this year, generating even more.

There are other ways of improving the bank's financial strength. Lloyds and RBS are currently offering to buy back their own debt from bondholders at a fraction of the issue price but a premium to the distressed levels at which it is trading in the market. If Barclays were to follow suit and exchange £10bn for new unsecured senior debt the deal would improve its core tier one ratio by about £2.5bn, Credit Suisse estimates.

Barclays share price surge on Friday said it all. At 173.8p, up 24pc, the stock has more than trebled in two months. It may yet choose to insure a couple of asset portfolios with the Government or even hold on and raise capital in the markets later this year. Either way, Mr Varley has swept the chips from the table. That's got to be a lot more rewarding than ping-pong.