Barclays: 2016 ROE Target Achievable Given Competitive Strength of Investment Bank
Half of Barclay’s risk-weighted assets (RWA) are in businesses which do not meet the cost-of-equity (COE, estimated by management at 11.5%). We expect improving returns at the investment bank, together with a mix-shift in the portfolio so that RWA are deployed more efficiently, to allow management to meet its 2016 target for the firm-wide ROE to equal COE. Specifically:
- Excluding legacy assets, the investment bank can achieve a 15% ROE by 2016 given its scale-advantage in flow businesses and ability to meet leverage requirements through actions, such as derivatives compression and repo-downsizing, with no meaningful revenue impact (see our note of Nov 10th entitled “Swaps Compression will Reduce Barclays Balance Sheet”).
- With the balance of quadrant-1 “growth” business units being high-return (including units from UK RBB, and linked wealth-management units, and Barclaycard), improved profitability in the investment bank means quadrant-1 businesses as a whole can generate an ROE of 15%
- The firm-wide ROE target is then achievable if other non-legacy businesses can generate returns equal to the COE (already true for quadrant-3 “harvest” businesses which are sources of capital and credibly-achievable for quadrant-2 “under-managed” businesses given cost-reduction plans).
The above analysis assumes no mix-shift in the current business portfolio. In practice, downsizing of quadrant-4 “legacy” businesses and growth of quadrant-1 businesses will add ~1.5% to firm-wide ROE (see Exhibit, left panel). This mix-shift to higher-return businesses gives Barclays leeway; for example, it can meet its firm-wide ROE target if quadrant-1 businesses generate an ROE of only 13% (see Exhibit, right panel) rather than our forecast 15%.