Barclays (LSE: BARC) (NYSE: BCS.US) may have avoided a government bailout during the financial crisis, but it didn’t escape unscathed from the Prudential Regulation Authority’s recent capital adequacy review, which found that Barclays had a £12.8bn capital shortfall.
Barclays immediately announced a package of measure to address the problem. The firm’s plan for a £5.8bn rights issue has grabbed most of the headlines, but I reckon that the devil is in the details, and that now might be a good time to sell Barclays shares.
Where to find a spare £12.8bn?
Barclays needs to find an extra £12.8bn by June 2014, and has a clear plan for achieving this. We already know that £5.8bn is going to come from a rights issue, but what about the rest?
According to Barclays’ plan, the remaining £7bn is going to come from a combination of reduced leverage on the bank’s own investments, retaining more of its earnings, and issuing £2bn of contingent convertible bonds. Known as ‘CoCos’, these special bonds can have their interest payments suspended at will, and can be converted into shares if the bank’s capital ratio falls below a certain level — effectively writing off the debt.
It’s not a bad plan, and should leave Barclays with a much stronger, safer balance sheet, but I’m not convinced that it’s a very appealing prospect for investors.
Stagnant returns
By June next year, Barclays should have another £12.8bn of capital on its balance sheet, but it won’t be able to do much with it. As the bank commented in its leverage plan, it will have a “limited ability to deploy the capital raised … in higher return areas”.
Barclays’ problem is that the definition of regulatory capital is pretty narrow, and basically means either cash equivalents or government bonds, neither of which generate very high returns.
I suspect that Barclays is going to struggle to grow or even maintain its earnings over the next year or two. An increase in retained earnings means that the bank will be almost entirely dependent on its investment banking division to generate increased profits — a risky strategy.
Barclays has trumpeted its plan to increase dividend payouts to 40-50% of earnings by 2014, a year earlier than originally planned, but I think that this may be an attempt to disguise the fact that the bank’s earnings are likely to be fairly uninspiring in the near-term future.
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> Roland does not own shares in any of the companies mentioned in this article.