Is it me, or has the City gone mad again? Irrespective of how dreadful the news, banking stocks just keep going up. Sure, the outlook may be less bleak, but it’s still downright ugly. It certainly doesn’t warrant the five-fold jump in Barclays’ shares over the past four months.
BUY Barclays (LSE: BARC), says ABN Amro
So, like the US Treasury, let’s do our own back-of-the-fag-packet stress-test on the group. We’ll assume that the recession triggers loan default rates of 1.5%, 4.5% and 3.0% for the next three years. At first glance, this prediction might seem harsh. After all, Barclays only reported impairment charges of 1.3% in the first quarter of this year. But in fact my estimate is more in line with the International Monetary Fund’s dire forecasts, and is also consistent with the American authorities’ own predictions of 9.1% cumulative bad debts over the next two years.
Indeed, the US treasury secretary, Tim Geithner, has insisted that institutions hold enough capital for their net tangible assets (NTA) to be at least 4% of risk-weighted assets by the end of 2010.
So what does this mean for Barclays? Well, as at December the organisation had customer loans worth £462bn, which, factoring in my assumptions, generates a total write-down of £41.6bn. That would wipe out the bank’s entire £30.8bn of NTA in one fell swoop. This isn’t check-mate on its own, though. Not if the dividend was cancelled, $4.4bn was received from the sale of its iShares unit, and other parts of the group met their targets. In that case, I estimate its tier 1 equity ratio as measured by Geitner would drop from 7% currently to around 4.5% by 2011. Yes, the decline would be painful, but Barclays – albeit perhaps only by the skin of its teeth – would avoid having to raise fresh capital.
But this is about as good as it gets. From a valuation perspective, the shares are still way overbought. The industry faces deep-rooted problems. I’d value the business at one times its 2011 NTA. After discounting back at 12%, that derives an intrinsic worth in today’s terms of around 170p a share, or 30% lower than current levels.
Worse still, there is also an outside chance that Barclays still needs to ‘bring out some of its dead’. Indeed, there is plenty of speculation that the company hasn’t yet taken the required medicine and marked down the value of its toxic assets as much as many of its competitors – which could lead to more nasties crawling out of the woodwork.
So with both corporate and consumer bad debts set to balloon over the next few years – and with Barclays’ balance sheet still looking like the quintessential black box – I wouldn’t touch the shares with a ten-foot barge pole. I believe they have been chased up by traders covering short positions and fund managers rebalancing their portfolios. For anyone else who has bought recently, it’s time to take profits.
Recommendation: SELL at 242.75p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments