Barclays’ (LSE: BARC) headline £374m loss and 50% reduction in dividend payments will rightly catch the eye of investors, but the bigger news should be the first announcement of new CEO Jes Staley’s plan to return the bank to growth.
The largest, and most controversial, portion of this plan is the sale of the profitable African division and retrenchment of transatlantic commercial banking. This plan is raising eyebrows because the 8.7% return-on-equity (RoE) at African operations is significantly higher than the 5.6% RoE posted by the investment bank. For investors who worried that the appointment of Staley, a former JP Morgan investment banker, to the top job foreshadowed a return to the bad old days, this was confirmation enough.
However, diving past the headlines, this plan begins to make considerably more sense. African operations may be profitable, but running retail banks sprawled across 16 countries isn’t only a drain on management focus, but highly capital-intensive and only contributes 12% of group profits. Divesting these holdings over the next two to three years will raise Barclays’ Common Equity Tier 1 (CET1) ratio from an industry-lagging 11.4% by a full 1%. Alongside dividend cuts, this will ensure the bank’s capital buffers surpass industry averages without resorting to tapping shareholders through a rights issue.
Investment bank issues
The elephant in the room remains Barclays’ massive US-centric investment bank, largely made up of the remaining bits of Lehman Brothers acquired in 2008. The 5.6% RoE at this division lags dramatically behind the 17.7% return from Barclaycard and 12.1% from retail banking. Even American banks with much healthier investment banking divisions, such as JP Morgan and Goldman Sachs, run RoEs below those of Barclays’ credit card and retail banking divisions. This leads me to wonder why management insists on tying up roughly 30% of the group’s risk-weighted assets (RWAs) in an attempt to remain a top-level investment bank.
The more mundane divisions of the bank, Barclaycard and UK retail banking, saw post-tax profits grow 18% and 6%, respectively, in 2015. These two divisions’ cost/income ratio was also better than the group’s long-term target at 42% and 60%, respectively, and much lower than the investment bank’s 78% ratio. Higher profitability and lower capital requirements at these two divisions lead me to believe they should be the drivers of Barclays’ growth going forward.
Turnaround plan
Exiting Africa and simplifying other business lines makes a great deal of sense as Barclays reins-in disparate global operations built up during and after the financial crisis. Moving away from the investment bank and focusing on the most profitable arms of the business would be a fantastic way to unlock significant shareholder value. The shares are currently trading at a 0.44 price/book ratio, which is less than half the level at which fully domestic-oriented competitor Lloyds trades.
If Barclays management moved to concentrate on its highly-profitable credit card and retail banking divisions, I believe it would be a bargain purchase with greater potential than other domestic lenders. At this time, however, I would remain on the sidelines as management begins the arduous process of divesting African assets and continues to muddle along with the oversized, low-return investment bank.
