Barclays: The Real Investment Bank Stands Up
Barclay’s investment bank represented ~55% of group equity but, on Thursday, management disclosed the more capital-intensive segments accounted for half of this and generated a mere 10% of investment-bank profits. With these segments consigned to a liquidating “bad bank”, the remaining “core” investment bank generated a 9-10% ROE in 2013, represents one-third of profits for new “core” Barclays, and has leadership positions in debt and equity underwriting in the key US and UK markets as well as scale- and technology-advantages in “flow” markets businesses including FICC.
- Barclay’s core investment bank, announced on Thursday, is refocused around advisory and corporate finance, the credit and equity markets activities to support the origination businesses, and those capital-lite rates/currency activities that can be migrated to an electronic platform (so short-dated, standard, and centrally-cleared products).
After also folding in loss-making businesses such as the European retail bank and the corporate bank outside the UK, non-core businesses represent fully 30% of group equity; the remaining core “good bank” generated a 12% ROE in 2013 and has strong growth potential in UK retail and consumer banking (representing just over one-third of 2013 core profits with an ROE of 11-12%), Barclaycard and Africa banking (representing just over and just under 15% of the business respectively with ROEs of 16-17% and 8-9%) and the investment bank (representing one-third of the business with an ROE of 9-10%). Management expects to at least sustain the aggregate core ROE of 12% while growing average equity of GBP36bn in 2013 to ~GBP50bn in 2016.
- The bad-bank created a 2013 drag on the ROE of 6% in 2013 (so that the group reported 6%); this drag is expected to fall to <3% by 2016 allowing Barclays to report a group ROE of >9%.
- The bad-bank is expected to downsize risk-weighted assets from GBP115bn today to GBP50bn by end-2016 so that average non-core equity in 2016 should be ~GBP15bn and hence average group equity ~GBP65bn.
- Putting these two elements together, management is guiding to 2016 earnings of GBP5.85bn or GBX35/share.
We believe the refocused Barclays can trade at 10x these 2016 earnings, so GBP3.50/share with the core bank valued at GBP50bn (being 1.3x estimate tangible equity of GBP38bn) and with an add-on of GBP8bn for non-core tangible capital; management expects to preserve this the sale and run-off.
- Core Valuation: Our valuation framework (see Exhibit) uses the ratio of forward 2015 earnings and current tangible capital. We expect Barclays core to generate 2015 earnings of GBP5.2bn, excluding restructuring or CTA charges; this represents a 13-14% return on current tangible equity of ~GBP38bn and corresponds to a 1.3x multiple of tangible book.
- Non-Core Add-On: The GBP8bn add-on comprises GBP14bn as the estimated tangible equity for the non-core bank less: GBP3.5bn for cumulative losses/restructuring charges; and, to avoid a double-count, GBP2bn expected to be reallocated to the core over the next two years.
In providing guidance for the sustaining a 12% ROE in the core bank while growing equity at a 10% CAGR, management assumes the investment-bank revenue environment remains “challenging” and continues to structurally reduce costs. The firm announced 7,000 headcount reductions in the investment bank (in additional to a previously announced reduction of 7,000 across the bank as a whole) and revised down its firm-wide expense targets b GBP500mm to GBP17bn in 2014 and GBP16.3bn in 2015 (of which the core business will represent <GBP14.5bn).