Barclays takes first step to a re-rating

February 12, 2013

By George Hay and Dominic Elliott

The authors are Reuters Breakingviews columnists. The opinions expressed are their own.

Barclays has taken the first step towards a re-rating of its persistently underperforming shares. New Chief Executive Antony Jenkins set out on Tuesday how the UK bank would move on from the disastrous era of his predecessor Bob Diamond, which left Barclays as the biggest loser from the Libor-fixing scandal. He’s on the right track – assuming he can carry his employees with him.

Jenkins reckons 36 out of Barclays’ 75 business units are either missing their cost of capital or pose risks to the bank’s reputation. Exiting the latter will mean saying goodbye to high earnings from some capital-light business like the bank’s controversial tax planning unit. Offsetting this, Jenkins will shave 9 percent off current expenses by 2015, with a 3 percent reduction in headcount, and shed 16 percent of group risk-weighted assets. The shrinkage promises to push return on equity above the bank’s 11.5 percent cost of equity, compared to 7.8 percent now.

If that sounds too easy, it is. The projections ignore the challenges facing Barclays’ capital strength. The bank’s Basel III core Tier 1 capital ratio of 8.2 percent is comparatively low. Getting above the industry standard 10 percent by 2015 could require over 5 billion pounds of organic capital generation. Meanwhile, the UK is forcing lenders to ring-fence their investment banking arms. Reconciling these obligations with Barclays’ commitment to raise the dividend payout ratio to 30 percent over time will be hard.

But the biggest swing factor for a re-rating may not be capital, but whether investors, and Diamond’s massed ranks of investment bankers, buy in to Jenkins’ cultural revolution.

The latter appear sceptical, even contemptuous, of signing up to woolly-sounding commitments to be ethical and socially useful. Jenkins’ status as a career retail banker won’t help earn him respect. But Barclays’ ongoing discount has always reflected fears of a big, Libor-style catastrophe around the corner. If investors believe this danger is receding, they may close the gap between Barclays’ 9.1 times price/earnings multiple, and the median of its European banking competitors at 11.4 times.

A rising share price would cement Jenkins’ authority and assuage the grumbling traders. The 6 percent bump on Feb. 12 suggests such a virtuous circle is at least possible.

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