Barclays and the reinvention of the UK banking sector
The meteoric rise and subsequent flameout of Barclays in the past decade has been a Sophoclean tragedy (one of many!) in international banking. Barclays, once a 300-year-old stodgy High Street clearing/colonial Quaker bank transformed itself into a global universal bank, with 50 per cent of its profits generated by disgraced former CEO Bob Diamond’s brainchild Barclays Capital. However, Barclays Capital proved the Achilles heel of the bank after the financial crisis, with catastrophic losses on structured products, a sordid Libor and foreign exchange rate rigging scandal that outraged UK regulators, the Bank of England and the Westminster parliament.
Diamond and his top executives were forced to resign. A trio of Barclays executives who arranged billions in emergency funding from the Gulf ’s sovereign wealth funds in a successful bid to avoid the fate of RBS and Lloyds TSB (nationalisation by Her Majesty’s Treasury!) now even face criminal charges before a London magistrate. Diamond’s successor, retail banker Anthony Jenkins, axed thousands of jobs at Barclays Capital but was unable to articulate a growth strategy or even a coherent vision of the future. His successor, former JPMorgan investment banker James “Jes” Staley has shed Barclay’s 100-year-old colonial African network and positioned the bank as an Anglo-American retail, cards, corporate and investment bank.
Staley has restructured the bank since 2015, shedding £74 billion in non-core assets, selling its stakes in African finance and releasing £3 billion in capital. The restructuring of the non-core division is almost over, even though it has cost Barclays £6.7 billion in cumulative losses. Barclays shares are down almost 18 per cent from their 245 pence high on the London stock exchange in February 2017. Barclays was the Cinderella of European banking in 2017 as investor patience was simply exhausted by litigation risk, a whistleblower investigation against the CEO, pressures on earnings and dividend payouts from the serial restructurings and fears over Brexit as well as the Serious Fraud Office probe of the 2008 capital raise, that burdened the bank with 14 per cent coupon preference shares that gutted profits.
Despite the multiple catastrophes he inherited, Staley has managed to stabilise Barclays. The Basel Three Tier One capital ratio is now a decent 13.2 per cent. The return on tangible equity has risen to six per cent. The Barclaycard franchise does not show a systemic rise in impairments. Even the downsized Barclays Capital has begun to take market share from its Wall Street, German and Japanese rivals in specific investment banking niches. Barclays is a world-class competitor in foreign exchanges, interest rates and credit derivatives trading and sales.
Barclays trades at a steep valuation discount to its peers at 0.74 times 2017 tangible book value, mainly on Brexit plus future litigation costs related to misselling of PPI insurance, the 2008 capital raise and the Libor manipulation scandal which could well exceed £2 billion in the next three years. The plunge in sterling and rise in inflation could also cause a rise in UK consumer, housing and credit card loan delinquencies. UK trade finance profits could well be a victim of Brexit.
I was not surprised by Barclays’s second-quarter 2017 net loss, made inevitable due to the charges on the African sale sand PPI misselling charges. Yet financial markets discount the future while human brains extrapolate the recent past. The non-core division will no longer pressure capital or earnings. So the dividend could well triple even as EPS rises in 201719. Staley aims to earn 10 per cent on tangible equity (note Credit Suisse and Deutsche Bank managed a miserable three to four per cent). The restructuring is over the Barclays’ valuation metrics will rerate as Group returns improve. Barclays was the worst-performing major bank in Europe in the first seven months of July. This will change. My target is 250 pence in the next 12 months. A 209,000 rise in July payrolls boosted both the US dollar and Treasury note yields. It is now politically impossible for the Federal Reserve not to hike interest rates one more time in 2017 or delay its balance sheet unwind. This means a steeper US Treasury yield curve, a steroid shot for Barclays share price.