Jenkins crashes back to reality as Barclays eyes £5.8 billion rights issue
Barclays announced a £12.8 billion capital hole on Tuesday, along with a sharply dilutive rights issue, that threatens to undercut CEO Antony Jenkins’ turnaround strategy, further bloody Bob Diamond’s legacy and challenge the bank’s US franchise.
Barclays CEO Antony Jenkins was immediately dubbed the anti-Bob Diamond when he was promoted to head up the UK’s second-largest bank by assets in August 2012 in the wake of the Libor scandal, as he embarked on a seemingly masterful act of reputational risk-management. After unveiling an ambitious turnaround strategy and ROE goals, cannily pre-empting the Salz review – the independent report into Barclays’ pay, culture and reputation – waxing lyrical about social-useful and values-driven banking, closing down the much-maligned structured capital markets unit, and embarking on a shareholder-friendly bid to reduce the compensation of key executives in line with peers, Jenkins’ low-key, politically correct management style found regulatory favour.
He has even been touted as a role-model for the incoming chief executive of RBS when Stephen Hester steps down by year-end.
Indeed, in February, with much fanfare, Jenkins presented the bank’s turnaround strategy, aimed at boosting returns to shareholders and replenishing capital organically, in a move he explicitly claimed had regulatory backing.
Meanwhile, outstanding challenges such as swaps mis-selling and PPI claims were seen by the market as eminently manageable legacy issues.
Indeed, the bank’s share price has outperformed Deutsche Bank since the German lender’s cash call, underscoring the confidence equity investors placed in the turnaround strategy, its capital position and cyclical earnings prospects.
On Tuesday, this argument was left in tatters, as Barclays announced a litany of woeful figures that threatens to undercut Jenkins’ strategy, further bloody Diamond’s legacy and challenge the bank’s US franchise.
- Firstly, Barclays announced the fourth-largest rights issue in UK history with a £5.8 billion one-for-four issue, at a 40% discount.
- Secondly, a larger-than-expected capital hole of £12.8 billion was revealed, thanks to a recalculation by the Prudential Regulation Authority (PRA) that took its leverage ratio to 2.2%, compared with the former 2.5% assessment, underscoring the challenge of assessing banks’ balance-sheet strength when it’s a de facto game of second-guessing regulators’ intentions.
- Thirdly, this capital shortfall will delay Jenkins’ target to achieve a positive ROE by one year to 2016 – flying in the face of market consensus, before Tuesday’s announcement, that, in Nomura’s words, “a capital raise would not change returns on target capital as the company is in a capital build mode”.
- Fourthly, the bank unexpectedly announced £2 billion in new mis-selling provisions, with the final bill potentially running much higher, as this new provision does not include “incremental consequential loss claims from customers classified as non-sophisticated”.
- Lastly, Barclays posted £1.1 billion in profit before tax for the second quarter, down 18% quarter-on-quarter, and short of market consensus, thanks to a 37% q-o-q fall in FICC revenues at £1.4 billion, dubbed a “material disappointment” by Investec analysts, thanks to waning demand for credit products and reduced client flows on the back of Fed-tapering fears. Nevertheless, this slide was partly offset by growth in equities and progress on cost-control.
|Barclays CEO Antony Jenkins|
In sum, this week proves the ghost of Mervyn King has yet to be exorcised from the UK banking industry and the challenges facing Jenkins’ post-Diamond legacy. The PRA’s unexpected exhortation that the bank will meet the leverage ratio of 3% by the end of June 2014 – granted, a six-month extension from its initial target – is widely seen as representing King’s parting shot to the banking industry.
Bank of England sources reportedly reveal that, in a belated attempt to fast-track UK bank-recapitalization plans, the former governor pressured colleagues to play hardball before he departed at the beginning of the month.
What’s more, the figures expose the folly of Diamond’s former strategy, banking that equity returns will immediately begin to normalize upon greater clarity over the regulatory agenda and a pick-up in economic activity, all the while gunning for an expansion of its cost base to propel Barclays from a tier-2 FICC player in the US to the top tier, buttressed by its strength in the European FICC business and its tier-one US equity franchise.
This strategy suggests even if Diamond was not forced out by the Libor scandal, given the blowing regulatory winds, it’s hard to imagine how he would have weathered calls for his scalp.
In the PRA’s words: “[The capital-raising strategy] is a credible plan to meet a leverage ratio of 3%, after adjustments, by June 2014 without cutting back on lending to the real economy.”
Instead, Barclays has promised that cuts will be made in “potential future exposure on derivatives, securities financing transactions and liquidity pool assets”. In other words, Barclays will be forced to reduce its risk-advisory and hedging services for corporate clients and downsize its involvement in the US repo market.
Questions will now surely be raised over the profitability and strategic direction of the bank’s US investment banking arm, already challenged by the Fed’s oncoming capital surcharge on foreign banks in the US.
Finally, how equity investors react to the £5.8 billion rights issue, planned for mid-September, will prove key to UK banking sentiment. In a bid to soften the dilutive issue, Barclays will lift its dividend to up to 50% of earnings from 2014, compared with 30%.
However, in the words of Nomura, in a report published before the announcement: “The main risk with raising equity here is that, while it helps to get to target capital ratio faster and thus arguably accelerating improved dividends, the regulator may move the benchmark again.”
And there’s the rub. The PRA has dramatically changed its tune on the bank’s capital-raising needs from February and dictated how Barclays seeks to address its £12.8 billion capital hole.
This confirms how UK banks will continue to trade at a regulatory-risk discount, which threatens to become a structural, rather than a cyclical, consequence of the global crisis.