European Banks: Barclays Over-Discounted
SEE LAST PAGE OF THIS REPORT Howard Mason
FOR IMPORTANT DISCLOSURES 203.901.1635
July 31, 2013
European Banks: Barclays Over-Discounted
- We estimate tangible book value per share, at year-end and adjusted for the rights issue announced yesterday, of GBP 3.10; the current share price of GBP 2.90 represents a GBP 3.2bn (~GBP 5 bn pre-tax) discount to this; we believe this is over-discounted.
- Notwithstanding the risk of further conduct provisions (for mis-selling payment protection insurance and rate-hedging products) and a raise of the bar for deleveraging, it is unlikely there is a balance-sheet hole of this magnitude given regulatory approval of Barclay’s leverage plan and, in particular, an increase in the dividend payout ratio from the current 30% to 40-50% for 2014 onwards.
- Furthermore, we expect Barclays to achieve an 11.5% return on equity by 2016 consistent, in our valuation model, with a stock price of GBP 4.30/share. Our assumptions (see Exhibnit) are conservative particularly around revenue growth. Specifically, we assume:
- revenue growth of less than 2.5% per year;
- run-rate operating expenses of GBP 16.8bn in 2016 versus management’s target of 2015;
- credit-impairment charges/other provisions increase at 7% annually from 2014 onwards.
- However, we also assume there are no further “conduct” provisions. As noted above, these would have to exceed ~GBP 5bn to account for the current share price discount to tangible book value.
Exhibit: Summary Financial Forecasts for Barclays
Discount to Tangible Book Value Hard to Understand
After adjusting for the GBP 5.8bn rights issue announced yesterday, tangible book value/share will be GBP3.10 by year-end (see Exhibit 1) and it is hard to understand why the shares are trading at a such a significant discount. Essentially, the market is expressing a view that the balance sheet is unreliable (perhaps because of a need for further provisions around mis-selling) and/or that there will be another cash call; both seem unlikely given the regulators have approved the bank’s leverage plan including, in particular, an increase in the dividend payout ratio from the current 30% to 40-50% beginning in 2014.
At the current price of GBP 2.90, we estimate the discount to year-end tangible book value (adjusted for the rights issue) as GBP 3.2bn or nearly GBP 5bn before tax.
Exhibit 1: Estimated Book Value Evolution for Barclays
Source: Company Reports, SSR Analysis
That said, the regulatory approval is against a 3% leverage ratio and, with a 5% standard in the US and the UK Parliamentary Commission on Banking Standards recommending a 4% standard for the UK, there is some chance regulators could increase their requirements. However, we believe Barclays would be given time to meet these through increasing issuance of hybrid Tier 1 securities (the current leverage plan calls for it to issue up to GBP 2bn), reducing the balance sheet, and retaining earnings.
Longer term, we expect Barclays to achieve its target return on equity of 11.5% by 2016 consistent, in our valuation model, with a share price of GBP4.30 (13x expected TBV/share of GBP3.30); we note the book value calculations assume a 30% dividend payout ratio for 2013H2 and 40% thereafter.
Barclays has been clear about its financial targets: a CET1 ratio of 10.5% under Basel 3 (being 150 basis points over the minimum target of 7% plus a 2% SIFI buffer) and a 3% leverage ratio plus a cushion. CEO Anthony Jenkins has also committed to a return on equity at least equal to the cost of capital (estimated at 11.5%) by 2016 and reducing run-rate operating expenses to GBP 16.8bn by 2015 (to represent a cost-to-income ratio in the “mid-50s”).
Our financial model (see Exhibit 2) is conservative in assuming: second half revenues are flat to first half revenues for 2013, and revenue growth thereafter is 2.5%; and run-rate expenses of GBP 16.8bn are not achieved until 2016 versus management target for 2015, and credit provisions increase at an annual rate of 7% from 2014 forward. A more aggressive assumption is that there will be no further provisions for mis-selling of payment protection insurance (“PPI”) and rate-hedging products; these provisions amounted to GBP 3.7bn (excluding the UK bank levy of GBP 345 mm in 2012H2) over the last 12 months.
Assuming the dividend payout rises to 40% in 2014 (and not higher in the 40-50% range indicated by management), Barclays will achieve an 11.5% return on equity in 2016 as targeted. It is clear from the model that the cost-reduction element of the “Transform” program is important particularly given our conservative revenue assumptions.
Exhibit 2: Summary Financial Forecasts for Barclays