It now seems clear that we may end up with a dual track investment banking system: a government sponsored system and a private system. Both will be heavily regulated and subject to increased capital requirements but it looks very possible that in both the US and Europe private banks will, at least initially, have more strategic and financial leeway.
That, at least, is the bet Barclays made when it turned down the UK government’s money last week and sought private capital to bolster its balance sheet.
“It was very clear from the conversations that I had with the UK Government over that weekend that it would, as a shareholder, influence our dividend policy; it would influence our lending policy; and it would become involved in the formulation of strategy,” Barclays chief John Varley said in a memo to shareholders this week.
Varley argues that the dilution shareholders suffered from Barclays latest round of capital raising was far lower than it would have been if the government had taken a share. What’s more, the strategic constraints of operating under tighter government supervision would have done long term damage to shareholder value, Varley says.
One issue he goes out of his way to address is the matter of bonuses, which he denies had anything to do with the decision.
“I know, by the way, that there has been a lot of speculation in the press that the issue of compensation – and in particular the bonus entitlements of the executive directors of Barclays, including me – had a significant impact on the decision we took,” Varley writes. “I want you to know that that point had no bearing on the decision. The Board cares about the interests of shareholders long before it cares about the interests of management.”
One question is whether or not Barclays, or anyone else, will be allowed to “get away with it.” That is, how long will the more tightly regulated, partially nationalized banks allow competitors who refused public funds to operate under laxer rules. No doubt there will soon be calls for a “uniform” system of regulation to apply to everyone, perhaps in the name of fairness. After all, why should a successful bank that doesn’t need a bailout be allowed a competitive advantage over its would-be failed rivals?
Here’s the full letter.
From: John Varley
There was a lot said and written in the media on Friday and over the weekend about our capital raising and I wanted to write today to share my perspective on what has been said so far (there will be more coverage in due course – of that I am in no doubt).
Often when I write to you I am trying to make sure that you have the arguments at your fingertips so that, if you are challenged by friends or family, or indeed by customers and colleagues, as to what we are doing and why, you have been able to develop your own views.
I am going to cover three areas in particular in this letter:
• Why we have decided not to take funds from the UK Government
• Why we chose to raise capital in the way that we did
• How the path we have chosen looks in hindsight – especially versus the UK Government option
You will remember from what I wrote at the beginning of October that when the UK Financial Services Authority made its decision, during the weekend of 11/12 October, to increase (significantly) the amount of capital which it required UK banks to hold, we had an immediate choice to make. Would we take capital from the UK Government or would we raise the money ourselves?
It is worth pointing out that, even though it didn’t seem like it at the time, the existence of that choice itself was a bit of a luxury, because some of our competitors were given no choice at all. They were required to take UK Government money as a condition for being open for business on Monday, 13 October.
The conversations we had around the Board table over that period were very clear: even in ordinary times, it is important for a business to have the right to determine independently what its strategy should be. And that point is even truer of extraordinary times like these. You don’t want your risk management compromised. You don’t want your strategic options constrained.
It was very clear from the conversations that I had with the UK Government over that weekend that it would, as a shareholder, influence our dividend policy; it would influence our lending policy; and it would become involved in the formulation of strategy. Of course the role of the Board is to protect the interest of shareholders and to create the circumstances in which, over time, we can maximise value on their behalf. And that was what was in the mind of the Board as we came to our decisions: we felt that our ability to do what our shareholders would expect of us would be compromised if Barclays was nationalised.
I know, by the way, that there has been a lot of speculation in the press that the issue of compensation – and in particular the bonus entitlements of the executive directors of Barclays, including me – had a significant impact on the decision we took. I want you to know that that point had no bearing on the decision. The Board cares about the interests of shareholders long before it cares about the interests of management.
Having made the decision we did, we needed to get moving quickly. At the time of our announcement, you might have seen that many commentators said that we would never be able to raise the capital ourselves. In fact just one week ago, the speculation was mounting that we would be stuck because of continuing stock market volatility and uncertainty. I don’t need to tell you that had this speculation gone on it would have hurt us badly. You have only got to look at the fortunes of HBOS, where confidence slowly evaporated, to see the dangers of taking too long.
As I said to you when I wrote last Friday, we had to make some difficult judgements around the Board table. Our instinct, and our track record, shows us to be believers in pre-emption rights – that means that when we raise new capital, historically we have offered the shares first to existing shareholders. However the experience of those UK banks who took the rights issue path during 2008 (HBOS, RBS, Bradford & Bingley) is not something that inspires confidence. I say that not to criticise competitors whom we respect, but simply to highlight the facts.
A rights issue launched now would have subjected our shareholders, and just as important our depositors, to a period of uncertainty which would have lasted through Christmas. In an environment where confidence is so fragile, the importance of certainty cannot be overstated. What we wanted to achieve was raising all the capital that we had agreed to raise simultaneously. So the words at the top of our mind were: size, speed, certainty.
Much of the coverage at the weekend has tried to compare what we announced on Friday with what might have happened had we taken Government support. There are one or two important points that have been lost in the coverage so far. First of all, the cost of the reserve capital instruments (or RCIs) that we intend to issue is not significantly different to the cost of the preference shares which those who took UK government money will issue, and that is true even if we take into account the cost of the warrants which attach to the RCIs. Second, the discount on the new shares that we are issuing is bigger than the discount that we would have got from the UK Government. But it is significantly smaller than the discount that would have been forced on us had we done a conventional rights issue.
My next point is rather complex but it’s important: it seems to me very clear that the only reason that we would have taken UK Government support was because we had lost the right to choice – i.e., because the FSA would have concluded that it was not safe for us to open for business on the morning of Monday, 13 October. That would have meant two things: first, the amount of capital that we would have been required to raise would have been much higher than the amount we are raising; and second that, by that time, our share price would have been a lot lower than where it actually was. What that means is that comparing the costs of the UK Government package had we taken it then with the costs of what we announced on Friday is simply inappropriate because it is comparing apples with oranges (but that won’t stop people trying!).
Just one last point in this area which is also significant: the dilution being suffered by our shareholders as a result of the capital that we are raising is just under 30 per cent. However, if you compare that with the dilution being suffered by the shareholders of the other banks being nationalised, it is a lot lower.
Let me finish by saying that I know that our shareholders, including lots of you who are shareholders yourselves, have had a lot to endure over the last 18 months. Our share price has dropped below £2; we diluted our shareholders in the summer and we are doing it again now. And we are not paying a final dividend for this year. But you know, as I do, that the circumstances of the last 18 months have been exceptional, and they have necessitated some exceptional responses.
We are emerging from this as one of the best capitalised banks in the developed world; in addition to which, our performance this year has been strong, as I said to you in my letter of Friday. That is a good combination: strong, profitable and independent. There are many banks in the world who wish today they could say that of themselves. And that creates significant opportunity for us in the weeks and months ahead.
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