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Barclays To Discontinue Trading In Non-Agency U.S. Mortgage-Backed Securities

forbes.com | June 19, 2015

Barclays has decided to pull out of the $700-billion non-agency U.S. mortgage trading industry in a bid to fall in line with stricter rules imposed by U.K.’s financial regulators. While U.S. regulations allow banks to ignore the credit rating of mortgage bonds while calculating their capital ratios, British regulators require U.K.-based banks to set aside more capital to cover junk-rated mortgage bonds. The restriction primarily applies to mortgage-backed securities that were originated in the U.S. before 2008 without any backing from Fannie Mae or Freddie Mac , as nearly all of them have been rated as speculative by credit rating agencies. Notably, rival RBS announced plans to shutter its U.S. mortgage trading unit last November (see RBS Eyes Complete Exit From U.S. Mortgage Trading Business).

Barclays will not see any reduction in headcount from this decision, though, as the bank will reallocate the employees affected to other businesses. The move comes within weeks of Barclays’ signing a deal to sell its Wealth and Investment Management franchise in the Americas to Stifel Financial, and highlights the brisk pace at which the bank is working through its balance sheet to improve its return on equity figure.

We maintain a price estimate of $18 for Barclays’ stock, which is about 10% ahead of the current market price.

Over recent years, Barclays has implemented significant changes to its business model as a part of its ongoing Project Transform. But the lukewarm economic conditions in Europe and the bank’s legal burden have hurt profitability. With stricter regulation making it difficult to maintain a full-fledged investment bank without sacrificing returns, Barclays has been forced to review several units under the division. The non-agency U.S. mortgage trading unit failed to make the cut because of two specific reasons.

Firstly, U.K. regulatory rules impose a higher capital requirement for mortgage-backed securities that carry a near-junk rating. This forced Barclays to set aside more capital for trading in these securities – something that nullified the impact of potentially higher yields from these securities by reducing the overall return on equity. And secondly, the higher operating and legal expenses involved in the unit makes it inherently expensive to run.

It must be mentioned here that Barclays has already slashed its MBS portfolio substantially over the years. The bank held less than £8.4 billion ($13.3 billion) in non-agency mortgage- and asset-backed securities at the end of 2014 compared to £18 billion ($28 billion) at the end of 2009. Also, Barclays will continue to trade in risk-transfer notes sold by Fannie Mae and Freddie Mac, newly issued securities, other asset-backed securities and commercial-mortgage bonds. This means that the bank’s decision will affect roughly 70-75% of its existing non-agency MBS portfolio, and will consequently result in a reduction in debt trading assets by between $9-9.5 billion by the end of the year.

 

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