Both Barclays and RBS are vulnerable to an economic downturn in the UK, say analysts at Citi, envisaging a £6bn equity issue from Barclays and more than double that - £12.5bn - for RBS in the not too distant future. Dividends from both banks too are looking “less secure”.
A prolonged downturn in the UK economy will “leave management with a limited range of alternative options.”
We show a range of valuation outcomes that suggests a potential floor valuation of 340p for Barclays and 275p for RBS. As a result of this analysis we lower our price targets from 450p to 400p for Barclays and from 400p to 350p for RBS, and retain Sell (3M) ratings on both banks.
Clearly, the premise for Citi’s analysis is a recession in the UK - not structured finance troubles. If the subprime crisis has stripped banks of their defences, then it may be the ensuing economic downturn that deals the real damage.
Specifically, it’s the leverage banks have taken on in recent months which is looking more and more dangerous. And that can’t just be measured by looking at Tier-1 capital ratios, say the Citi analysts:
…too much focus on a single measure, such as the Tier 1 ratio, perhaps caused the market to overlook other risks linked to off-balance sheet vehicles and the changing composition of Tier 1 capital.
If more attention had been paid to accounting-based measures such as the tangible equity/asset ratio, it would have been harder for banks to seemingly remove assets from the balance sheet without necessarily removing the economic risk.
Indeed, on tangible equity/asset ratio - which would encompass assets Barclays and RBS have in off-balance sheet conduits:
Barclays and RBS… are the two most undercapitalised banks in Europe.
The tangible equity/asset ratio ignores risk weightings, so it’s a pretty bearish measure. But in the context of a structured finance contagion to broader consumer-debt asset classes, it’s worth keeping in mind.
