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Moving goalposts – Barclays’ rights issue is an upfront response to a last-minute rule change

08/08/2013

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

Tangible book value and capital – as regular visitors to The Value Perspective will be aware, whenever a UK bank releases its results, these are the aspects on which we focus above everything else. When Barclays published its annual interim results at the end of July, however, this was for once not the case although, for the sake of consistency, let’s briefly address those two points.

As a result of £1bn-worth of extra provisions the bank has made for potential misselling claims relating to payment protection insurance and interest rate hedging products, Barclays’ tangible book value, which offers some idea of the changing upside in the business, has taken a step backwards. Conversely its capital, which indicates what is happening to balance sheet risk, has edged in the right direction.

This time around, though, that was all a bit of a sideshow as, alongside its results, Barclays announced it is to issue £5.8bn in new shares. This is intended to help address a £12.8bn shortfall in its capital that has come about as a result of the Prudential Regulation Authority (PRA), the new banking watchdog, introducing some tough additional requirements for banks’ balance sheets at the last minute.

Barclays actually had until June 2014 to fix this matter but has instead chosen to address it quickly and head-on by taking what it has itself called “bold and decisive actions”. Such behaviour is unusual from banks or indeed any other business which, given the chance, would be likelier to kick the proverbial can down the road and hope something came along in the meantime to address the PRA’s concerns.

So Barclays is going ahead with the £5.8bn rights issue in addition to a variety of other programmes to raise the necessary additional capital. The upside of this is, in the longer term, it should leave the bank with one of the strongest balance sheets in the sector. In the short term, however, those investors who thought the business was cheap with a good enough balance sheet may have to revisit that view.

One extra ‘carrot’ Barclays is brandishing – and which, given it is flagged up in the results, has presumably received the blessing of the regulator – is that it will be allowed to initiate a pretty healthy dividend by 2015. that is slated to be somewhere in the order of a 40% to 50% payout ratio, which on the current share price would be in the region of a 6% yield.

Not only would that clearly be attractive in its own right, it would come in conjunction with a balance sheet that should by then be super-strong and from a group that operationally is doing well – whether you look at the investment bank, which is benefiting from the rise in M&A activity while cutting costs aggressively, or Barclaycard, which is just an excellent business, or the strong UK arm.

So, irrespective of the macroeconomic environment, Barclays’ businesses are broadly looking in good shape and, now the regulator has effectively moved the goalposts in the middle of the game, the bank has not sat around feeling sorry for itself but has set out a strategy for doing what has to be done in an upfront and punchy manner.

What does that all mean for investors in Barclays? While the short-term rewards may have tapered somewhat as a result of the rights issue and other capital-generating measures, the risks also look to have reduced significantly. The appeal of this new risk-reward balance will be down to individual tastes although it still appears an attractive proposition to investors with a longer time horizon.

Author

Kevin Murphy

Kevin Murphy

Fund Manager, Equity Value

I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials.  In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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