|Source: DataStream, Brewin Dolphin|
Over the past few days, there has been speculation of a capital raising programme amounting to around £4bn so when the announcement came this morning of a £5.8bn rights issue, the market was surprised by the scale of it. However, throughout the day, there have been a number of questions asked concerning the size and whether it will be enough.
Banks have to hold capital to suffer losses in case any of the loans they make are not fully repaid. Loans are a bank’s assets whereas its liabilities include deposits. If the bank makes bad loans then they are first offset against the capital. This is why savers can deposit in banks without feeling their deposits are at risk.
Part of the fun of being a banks analyst is trying to determine whether the banks are complying with the different measures of banks’ capital relative to the different measures of banks’ assets.
Barclays is aiming for a leverage ratio of 3% (capital as assessed by the Prudential Regulatory Authority relative to total assets) by June 2014 despite having operations, in the US, where there is a requirement for banks to have a 5% leverage ratio. The higher ratio will not apply to Barclays as its holding company will have assets of less than $700bn. Management stated that the capital raising materially reduces the uncertainty around Barclay’s capital but regulators are likely to want to push the leverage ratios higher over time.
Barclays is aiming for a 10.5% Core Tier one ratio (a different measure of capital divided by the risk weighted assets) by the beginning of 2015, 1.5 percentage points above the 9% minimum. There are therefore questions surrounding the possibility of the leverage ratio requirement increasing and what impact this would have, specifically when much of the ‘good news’ over the rights issue surrounded an increased dividend payout ratio and specifically higher returns to shareholders.
Does this mean that the dividend, which might entice investors to participate in the rights issue, would be at risk if regulation increased? We would argue not. Barclays had the opportunity to raise more – the rights are underwritten by other banks and we are sure that management would have assessed this risk. When we look at global banking regulation, requirements and companies, there are clear leaders at the front of the curve: US, Nordic and Swiss banks have high requirements and some companies that are sitting on higher ratios than mandatory.
However, increased capital means higher hurdles: to get Return on Tangible Equity above the Cost of Equity, the types of business undertaken needs to be assessed. Pure ‘old fashioned’ banks which lend to the economy (not wealth managers or investment banks) will struggle to increase their leverage ratios further. The ‘Capital Taliban’ as Vince Cable calls them (the regulators), will find it hard to quickly push through higher regulation in our opinion.
Therefore, we see the investment case for Barclays, once the rights issue is behind it, as attractive. It has a market leading position with good global end-markets, a strong investment bank and an attractive retail offering. Add to this the fact that the dividend should be growing with the increased payout ratio and we expect it to be a long term growth story.