Oh the banks! (3) Barclays PLC

Sheik Hamad bin Khalifa Al Thani of Qatar, saviour of Barclays, courtesy Wikipedia

Five years have elapsed since the financial crisis and it is time to consider investing in banks again. See http://thejoyfulinvestor.blogspot.co.uk/2014/01/ohthe-banks-1-andhsbc-holdings-plc.html

Barclays shareholders have had a rotten time since the financial crisis. Shares worth over six pounds in August 2007 collapsed to 47p by March 2009. Today they stand at 264p. The following graph compares Barclays' share price (in blue) to HSBC's share price (in purple) since 1988.

Graph courtesy Barclays website, click to enlarge

 

The main concern for investors is the quality of Barclays' management. Consider:

The ABN Amro deal that failed. Barclays agreed to buy ABN Amro in 2007 for €67.5 billion when a consortium led by RBS outbid Barclays for the Dutch bank. The collapse of RBS was largely the result of paying 49 billion pounds for ABN Amro that went on to lose billions in its US operations. Barclays would have collapsed had the deal gone through.

 Caught short of capital in 2008, Barclays has floundered to keep afloat.

·         In July 2008, Barclays attempted a rights issue, which failed.

·         In November 2008, Qatar and Abu Dhabi investors put 7.3 billion pounds into Barclays in exchange for 30% of the bank. UK authorities are looking into possible bribes paid to intermediaries and to the possibility that Barclays loaned funds to Qatar to invest in the bank.

·         In 2009, Barclays sold iShares to BlackRock for 8.4 billion pounds and raised a further 6.5 billion pounds capital by cancelling its dividend (2 billion pounds) and via another rights issue (4.5 billion pounds).

·         In 2013, Barclays raised a further 5.8 billion pounds via a rights issue as part of plan to enable it to reach the minimum capital requirements set out by the Prudential Regulation Authority. The total shortfall was 12.8 billion pounds and the bank aims to meet this requirement by June 2014.

Barclays has a reputation for unethical banking.

Like other UK banks, Barclays is paying for mis-selling payment protection insurance and for rigging LIBOR rates. But it has also been fined for failing to provide adequate investment advice to its customers, mis-selling interest rate swaps to its customers, for manipulating electricity markets in the USA, and for evading sanctions on Iran. Further, HMRC ruled that Barclays had evaded tax. The total cost of fines and compensation total 6.2 billion pounds. 

The bank that puts bonuses before shareholder returns.

Barclays has paid out 8.6 billion pounds in bonuses to staff between 2011 and 2013, when profits are declining and the bank had to go to shareholders to raise new capital.

Sliding profits and capital inadequacy, coupled with persistent signs that Barclays is unmanageable is reflected in the recent volatility of its shares (in blue) compared to HSBC (in green) and the FTSE 100 (in red) of which it is a component.

Courtesy TD Waterhouse, click to enlarge

 

Unlike HSBC or Santander, Barclays is both an investment bank and a retail bank. The investment bank, after the acquisition of Lehmann's core business, is centred on London and New York. Considering that Barclays reckons its cost of capital is 11.5%, neither is doing well.

By business in pounds billions for 2013	Attributable Profit/(Loss)	Average Equity	Return on Equity%
Retail (UK, Europe, Africa, Barclaycard)	(0.1)	17.9	Neg.
Investment Bank	1.5	19.0	7.9%
Corporate, Wealth & Investment Mgt	(0.4)	10.2	Neg.
Head Office and Other Operations	(0.5)	5.1	Neg.
Total Bank	0.5	52.2	1.0%

                Source: Barclays 2013 Presentation

But this is not unique to Barclays as the poor results from RBS and Lloyds show.

 Successive fund raisings have strengthened Barclays balance sheet:

 1. Core Tier 1 Capital ratio is now 13.2% and equity/total assets 4.9%, which more than meet the Basel III capital reserve requirements of a 6% minimum for Core Tier 1 Capital and 4.5% for equity/assets.

2. The Loan to Deposit Ratio, a measure of liquidity, is down from 110% in 2012 to 101% in 2013. And the Liquidity Pool exceeds wholesale debts by 45 billion pounds.

3. Standard &Poor's rates Barclays long-term credit A-.

4. Non-performing loan coverage is up from 42% in 2012 to 47%. This leaves 9.7 billion pounds of non-performing loans that are not provisioned for.

But the bank's high cost to income ratio of 71% is responsible for its poor trading performance. By comparison, Santander's cost to income ratio is 50% and HSBC's is 54%.

Other negatives are:

1. Earnings per share in the last three years average 5p, which is much below the preceding 3-year average of 56p.

2. Thanks to the rights issue, equity per share is down from 414p in 2012 to 331p in 2013.

3. The return on equity (ROE) is a miserable 1%. Even after substantial adjustments that management make*, ROE is still just 4.5%, half of the prior year's adjusted ROE. *Items excluded from the adjusted measures are: the impact of own credit; disposal of the investment in BlackRock, Inc.; the provision for Payment Protection Insurance redress payments and claims management costs (PPI redress); the provision for interest rate hedging products redress and claims management costs (interest rate hedging products redress); and goodwill impairment. Source: 2013 Barclays Results.

Barclays plans to improve profits by:

·         Reducing its cost base by 1.7 billion pounds by 2015 - 12,000 staff are to go.

·         Reducing the number of UK branches, perhaps by as much as a quarter, and promoting online banking. Barclays bought ING Direct UK in 2012, which brought it 1.5 million customers.

·         Making Barclays the 'Go-To' bank. This was explained by the new CEO, Anthony Jenkins, in the 2012 Annual Report.

 "Being the ‘Go-To’ bank means being the instinctive partner of choice for anyone looking to do banking business, whether a small business, first-time house buyer, or a large corporate undertaking a complex merger or acquisition deal. Customers and clients will benefit from being firmly in the centre of everything we do."

The CEO wants a "greater level of customer and client satisfaction" and "more business from more customers and clients." There is plenty to do. In the latest Which? survey, Barclays, together with RBS and Santander, trails other banks in customer satisfaction.

·         Reducing its operations in its main, loss-making Eurozone markets, Spain, France and Italy.

·         Integrating Absa Group Ltd, South Africa's largest bank which it bought in 2005, into its other African businesses. And expand its operations in Africa.

At 264p, Barclays shares are valued at a 20% discount to net asset value, yield 2.4% and are on a PER (adjusted earnings) of 17. If one assumes that the great bulk of nasty surprises is behind Barclays, that the adjusted earnings of the last two years is a fair base going forward, then my valuation model values the shares at around 220p.

 

Investors will note:

1. Barclays is essentially a mid-sized investment bank linked to a mid-sized retail bank with a good business in Barclaycard. Successive CEOs have had difficulty managing both sides of the business.

2. The present CEO is a long-term Barclays executive and he seems out of his depth. The bank has suffered from a high cost to income ratio for years, and yet the planned cost cuts will not radically change Barclays' cost structure. And the bank continues to pay out large bonuses, which exceed the planned cost cuts. So, although one key objective is to bring down compensation payments, the compensation to revenue ratio increased from 39.6% in 2012 to 43.2% in 2013 at the Investment Bank.

The CEO, who has waived his bonus for the last two years, understands that large bonuses are out of line when the bank is short of capital. But he doesn't seem to be able to implement a more rational bonus policy. Sooner or later the bank must bring in a team from outside the bank to lead it out of the morass it is in.

3. In the only large share transactions by directors in 2013, the CEO sold shares worth 2.9 million pounds at 308p a share in March, 4 months prior to the announced rights issue. The CEO took up 1.1 million pounds worth of shares at the rights issue price of 185p a share in October.

4. Barclays operates in regions with low political risk.