Barclays: Expect Improved Guidance for Profitability and Leverage
With 2013 results and cost-cutting measures on Feb 11th, we expect Barclays to announce: (i) a 5-year target for a low-to-mid-teens return-on-equity replacing the current anemic target for a return in excess of the cost-of-equity, estimated at 11.5%, by 2016; and (ii) a reduction in leverage exposure of GBP50bn and increase in the cumulative target for mid-2014 to GBP100bn (from GBP65-80bn). These targets are consistent with a share price of 350p representing 1.2x tangible book of 295p.
- Improved guidance for leverage exposure will be enabled by derivatives compression and downsizing of the matched repo book so reducing CRDIV add-ons of GBP295bn and GBP98bn respectively. The new target cuts leverage exposure below GBP1.4bn by mid-2014 and, given pro-forma capital of GBP43bn (after the rights-issue of GBP5.8bn, GBP2bn of AT1 issuance, and GBP4.1bn of PRA capital-haircut), makes a 3% leverage ratio visibly achievable.
Investment Bank: The swing factor to profitability at Barclays is the investment bank which absorbs ~40% of capital and has a target return-on-equity, after a 3% drag from legacy portfolios (such as the credit correlation book) of 11-12% by 2015. Given legacy-book run-off and the benefits of a business mix-shift to flow products come through (in the form, for example, of a comp-to-income ratio in the mid-30s versus the current 40%+ and asset growth materially below single-digit income growth), we expect management to confirm return-guidance for the mid-teens over a 5-year horizon.
- Barclays is structurally-advantaged in FICC (over 40% of IB revenues) because of technology investment to lower cost (through automated pricing and risk management without the need for human intervention) and increase customer value-add (through providing access to liquidity across multiple trading venues). These investments make the business scale- rather than capital-intensive creating advantage to Barclays as a top-3 player in flow rates, flow credit, and G10 currency (see Exhibit below).
UK Branch Banking and Barclaycard: 25% of Barclays capital is deployed in businesses which are intrinsically advantaged including UK branch-banking (absorbing 15% of capital where Barclays is one of the “big-4” players in a stable oligopoly and can expect through-the-cycle low-to-mid-teen returns) and Barclaycard (absorbing 10% of capital and already generating high-teens returns).
Corporate Bank and Europe/Africa/Wealth: The rest of Barclay’s capital is in businesses which are under-performing (15% in the corporate bank and the balance spread roughly equally between branch banking in Europe, branch banking in Africa, and wealth/investment management). At the corporate bank, for example, returns-on-equity are 7% because of a cost-to-income ratio of 55%. The bank loses ~GBP200mm/quarter in retail and branch banking in Europe, and the wealth and investment management business generates a return-on-equity of 2% with a cost-to-income ratio of 90%. We expect these businesses to be subject to aggressive expense-management.