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Bradford Bingley Company: Case Study

About Company

It is a company that offers a wide range of products to its customers. The products are saving products, financial planning service, insurance products, mortgage products and loans. The company was formed in 1964 after the merger of the Bingley Equitable and Bingley that was formed in 1851. It was formerly a building society, but in the year 2001 it was converted to the Bradford Bingley Public Limited Company.

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Rights issue refers to the process where the management of the company offers shares to their existing shareholders so as to raise money for running the operations of the company. The rights issues are usually transferable thus the holders can sell them to their shareholders and the customers on the open market. They can be sold separately from the shareholders to other investors during the life of the right or the shareholders may take up the rights or they may lapse them according to their will although when they lapse they can exist no more (Louth, N. 2008).

The factors that a financial manager should take into consideration when issuing the rights are subscription price per new share, number of new shares to be sole, value of the rights, the effects of the rights on the value of the current share and the effects of the rights to the existing and the new shareholders.

The rights issues may be underwritten. The duties of an underwriter are to ensure that the funds sought by the company will be raised according to the agreement that has been issued by the company. The underwriting agreement is the document shows the agreement that exists between the underwriters and the company. The agreement allows the underwriters to subscribe for the shares offered and that are not taken up by the shareholders. It enables the underwriters to terminate its obligations only in the circumstances that have been defined in the agreement.

The rights issue transactions involves allowing the company exists shareholders the right to subscribe for the newly issued shares in proportion to the shares that they hold. The rights issues are used so that the company can raise money that can be used to expand the company’s operation and also to carry out a large takeover of a company. The shares that are obtained after issuing the right issues affect the per share calculations such as the earnings and the dividends per share.

The Bradford and Bingley’s Chief Executives officer quit the company because it was experiencing credit crisis and thus the performance of the company had started to decline. The management of the company stated that they wanted to raise money of about £300 so as to boost the liquidity levels of the balance sheet of the company. He also stated that he would raise the rights issue so as to strengthen the financial status of the company.

The Sunday Times reported that the company would experience profit warming that would be contained within the banks rights issue document. The profits of the company also fell by almost half of the profits that were being earned by the company after the management had the assets written down including those of the United States Mortgage. The pre-tax profit of the company fell from £246m in 2006 to £126m in the year 2007. The banks also recorded huge losses due to the problem of the mismanagement of the United States housing market.

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The Bradford and Bingley Company experienced problems of credit crisis because the borrowers in the United States defaulted to pay up their loans once the interest rates that were linked to the loans started to rise. The loans had been grouped together, repackaged and then later sold to the banks as an investment that derived high returns to the investors. The company also asked for bigger deposits from the banks and raised the interest rates for the new products and also raised the mortgage arrears, unfortunately the borrowers declined to pay up their loans and this lead to the credit crisis of the company. The company was reported that it would gain back its financial position through issuing the rights issue. The performance of the company declined even after the issue of the rights thus the management decided to scrap the issuance of the rights by replacing them with the restructured issues that were worth £258 million.

The reasons for using the rights issue to raise the companies money was because it would strengthen the group’s capital position and reduce the impact of the reduction in the value of some of its treasury investments. According to some analysts they stated that the performance of the shares was weak since the investors were not taking up the shares and this resulted to large chunks of shares that were left to the underwriters to seek the issues of the rights issues. The sought out of the right issues was costly and time consuming and yet the company was not deriving enough revenue for the company.

It was also reported that share prices that would be offered to the shareholders would decline this is because of the deteriorating house market, macroeconomic down turn and the emergency rights issue that would delay the raising of capital for the company.

The current dividend policy of the company and whether it is successful or not. A dividend policy refers to the policy that is used by a company to determine how much dividends it will pay to its shareholders. The dividend policy is established on the basis of how it will impact on its investors and the perceptions that the company will be viewed at by the financial market. The policy is also implemented on the basis of the company’s situation now and in the future. It also depends on the preferences of the investors and potential investors that would be interested in the management of the company.

The directors of the Bradford and Bingley’s company stated that they would declare the dividends of the company on the basis of fund that would be present on or about the 10th calendar day of every month during the financial period of the company. According to HBOS they stated that the divided policy of the company would be distributed on the basis of 40% of the net profits of the company as on March 2008. The previous dividend policy was calculated by dividing the old annual dividend per share and the earnings per share of the company. For example the 2007 dividend was 49p while the earnings per share were 106p:

49/106=0.46 thus the payout ratio was 46p per pound of earnings that is 40%

The declaration of the dividend policy to be 40% from 46% shows a decline in the payment of the dividends to the shareholders. Although the 2008 dividend policy had hidden charges such as dividend cuts as cuts in the payout ratio and the dilution of the existing earning over the shares, the dividend policy did not show the its increase in value, but a decline in its value.

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The dilution of shares would be 100/140 that is the old number of shares that would be divided by the number of share the result would be 0.71. The old Earnings per Share EPS of 106p would be spread over to the new shares thus

106p x o.71 = 75p

When the earning per share is applied then the new payout ratio would be 40% x 75p=30p

According to the HBOS’s statement the shareholders of the company would receive 30p per share on the dividends that would be issued to them thus the shareholders of the company would receive the shares whose value would be less than what the statements would reveal to the company as the shareholder would receive the two thirds of the dividends of what they currently receive.

The dividend yield of the company as per 2007 was 9.8% but as per 2008 it would be 6.9% as it would be derived by taking the 30p per share in dividends by the average value of the shares at 435p = 30/345 = 0.69.The dividend policy does not appear to show the performance of the company as been successful, since the value of the dividend seems to decline as the company continues with its operations. From the year 2007 the dividend yield was 9.8% and the year 2006 it was 6.9% this thus shows a decline in the performance of the company.

The company had experienced difficulties due to the economic condition of the country of credit crisis that led to the decline of the net interest margin at the increasing arrears. The underlying profits of the company as at the four months of 2008 was £56 million as compared to £108 million in the year 2007 this showed that credit crisis had affected the performance of the company. The presence of the capital base and skills that TPG would be provided by the company would enable to access market opportunities available in the medium term of the company and this would improve the performance of the company.

According to Mathias Calice a partner at TPG he stated that the company’s performance would be improved through having capital that would provide the platform for the potential growth and the profitability of the company. The TPG Company is a company that was established in the year 1992 and it had more than £50 billion assets under the management and offices of United States, Europe and Asia. The company has extensive experience with the global public and private investments and it invests in the world-class franchises across a wide range of industries such as financial services.

The estimation of the company’s share price as at 2007 using the dividend growth model and the capital asset pricing model.

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Dividend growth model

The dividend growth model is the model that determines the company’s current price of stock as its dividends next period dividend by the discount rate less the dividend growth rate. The model assumes that the basis of valuing stock is determined by the current dividend, growth of the dividend and the required rate of return.

The formula for the dividend growth model is

Value = (current Dividend x (1 + Dividend growth))

(Required Return – Dividend Growth)

The Bradford Bingley divided growth rate would be 15% and the required rate of return is 20%. The current dividend of the company would be 8.7p.

The board of directors of the company stated that it would impose a final dividend of 11p and would lead to the declaration of dividends to 16.5p and this would show an improvement of the performance of the company by 11%.The board also stated that it would expect the future growth of the company to be balanced by the capital requirements of the company (SandherJ.2004).

Capital Asset pricing model

It is a model that is used to determine the appropriate required rate of return of an asset. The model takes into account the assets sensitivity to its non diversifiable risk that is systematic risk or the market risk. It is represented by the quantity beta (B) in the financial industry as well as the expected return of the market and the expected return on the theoretical risk-free assets. The expected return of any security is determined by its beta coefficient, the reward-to-risk ration for any individual security in the market that is equal to the market reward-to-risk ration.

E (Ri) – Rf = E (Rm) – Rf

ßim

or

E(Ri) = Rf + ßim (E (RM) – Rf)

Where E(Ri) is the expected return on capital asset

Rf risk-free rate of interest

ßim beta coefficient which is the sensitivity of the asset returns to market returns.

The reasons why the actual share price differs from the estimated share prices

The prices of shares depends on the businesses investment environment if the environment is conducive the value of the shares also increases. The investors may pull the financial prices away from their long term trend level and this may affect the value of the shares of company during a given financial period of a company.

When the investors are evaluating the value of the shares they react differently to the how the shares are in the stock exchange market. The reactions of the investors may either be optimistic or pessimistic reactions. For the excessive optimistic reactions the investors may have the prices of the shares as been evaluated as been high while the pessimistic investor they may the share prices to be unduly low.

The common stock prices of Bradford and Bingley Company today, is based on the expectations of the future performance and the forward looking valuation of a company. The actual share price can differ from the estimated share prices that will be charged on the shares of the company.

The short selling of shares can cause damage to the health of the real business as it can have serious verification on the respective employees and the customers of a company. In case of banks if the share prices fall, it becomes harder and more expensive for those banks to raise fund that is needed to run the affairs of a company. It further reinforces the downward momentum to the share prices because the prospects of the bank worsen as the cost of capital rises.

The implications of the undervalued company

The undervalued companies usually have low share price that does not reflect the assets that a company owns. The management of the undervalued company may be require the share prices to undergo a change in price so as to increase its valuation.The valuation of the share prices can be undertaken through issuing a premium to the shares or by having a price drop of its premium that is not being considered to lead to the undervaluation of a company. The firms that have investment strategies that have specific characteristics are termed as undervalued and although they can have excess returns than the firms without these characteristics.

The strategies that can be used to determine whether a firm is undervalued or not is tested through creating the portfolio of firms that possess these characteristics at the beginning of the financial time period of a company. The examination of the returns of the firm over the financial period of a company can be used to evaluate whether a firm has been undervalued or not, if the returns of the company are low this means that the company has been under valued.

The variables that are used to classify the undervalued companies are defined using investment strategies such as: guides that have variables that are observable, though they may be numerical in nature, the data of the variable that is collected from the firm in diverse method at the start of the testing period is also and investment strategy and the firms are classified into portfolios that are based on the magnitude of the variables.

The company’s that have their price earnings that are low are reffered to as being undervalued. When the price earnings (PE) of a company’s transactions are high the investors may have more earnings and this implies that they have larger implied expectations for the future earnings growth for the company.

The other factors that are considered when determined whether a company is undervalued or not is that: the rate of the firm, if the company has less component parts thus the investor may push for the break up of the firm, spin off and split off of the company’s financial statement. The company is undervalued when the firm is too conservative in the way it uses its debt, thus the solution for this problem is to push for the higher leverage and recapitalization of the firms assets.

Market factors

It refers to the external agent that determines how the demand for or the prices of a good or service are affected. The management of Bradford Bingley Company stated that it would increase the dividend amount of 18th of the month and it would also reduce the dividend amount to the 19th of the month so as to show the presence of the ex-dividends for the company. The declarations of ex-dividends to a company without the permission of stakeholders of the company would be a violation of the expectations of the market factors of the company.

Market index

The market index is an index that is used to show the market trends in its securities. It is designed to measure the prices changes of the overall market such as the stock market or the bond market.

Cost of equity

It is the return of the investment that is required by the equity holders of a firm. It is calculated by using any number of different theoretical approaches that takes into consideration the current and long term yield requirements of the firm’s investors.

The formula for cost of equity is = Dividends per share + Growth rate of dividends

Current market value of stock

It represents that the market demands as compensation in exchange of owning an asset and of bearing the risk of ownership. It also represents the opportunity cost of investing in the shareholders. The compensation that the shareholders get is the dividend and the capital gains.

According to Morgan Stanley he stated that the cost of equity had fallen to its lowest level relative to its debt due to bad economic conditions of the market. Ian Scott stated that the company’s balances to equity issued and buybacks announced would be close to zero. It was noted that the cost of equity funding was more expensive than the bank debt during the financial period of the company.

Share price

It refers to the price of the single share of the company’s stock. When the stock is purchased the owners become the shareholders of the company that issue the shares. The share prices of a company are directly related to the company’s earnings and their dividends.

It can not be used to measure the valuation of an underlying company this is because the number of shares that understand to a company varies for each publicly traded company.

It was noted that the company’s share price had fallen and thus they would curtail the ambitions of the investors that would be interested in strengthening the balance sheet of the company through the issuance of the rights issue. The buy-to-let mortgage specialist stated that the raising of funds through the rights issue would not reflect the any improvements in the share prices as the value of the shares had declined due to low demand for the product in the market. The company’s share price had declined by 70% as at 2007 and the recent studies showed that that the shares would fall from 135p as at May16 at 8am to 111p at the same time on May 20.It was recorded that the shareholders would not purchaser the shares as the value of the shares had lost value due to the existence of the credit crisis in the market.

The net interest margin of a company is the difference between the borrowing rates and the savings rate The company net interest margin had declined significantly thus for the company to overcome this problem it imposed restrictions that would prevent this problem from happening these are: increasing the interest rate of the loans and mortgages issued to the customers. The company would restore the company net interest margin thorough imposing tough conditions such as cutting down the saving levels of the company so as to maintain the profitability of the company., the company would also increase the staff deductions and increase the call centers and the offshore facilities so as to maintain the right net interest margin of the company.

The management of Bradford and Bingley Company should ensure that imposes the right mechanisms that the operations of the company can be carried out effectively. The economic condition of the country although they affected the performance of the company they should have employed qualified personnel to carry out the transactions of the company as so to avoid the problem of over sharing the share while the demand for them is low. The management should have carried extensive research so as to ensure that it could predict when the demand for share would there so that to avoid deficits from occurring to the company.

Reference

Bradford & Bingley chief resigns Bradford & Bingley branch. Web.

The basic guide to rights issues, By Louth, N. 2008. Web. RNS Number: 7115V

Bradford & Bingley PLC 2008.

Bradford & Bingley plc 2008.

United States, Canada, Australia, Japan or South Africa. Web.

The Dividend Growth Model. Web.

Peter Green Director of Treasury & Balance Sheet Management SandherJ.2004 Balance Sheet Manager. Web.

What are we? FTSE-100 plc – floated. Web.

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