Shares in Barclays (LSE: BARC) (NYSE: BCS.US) are up around 1% on news of slightly better than expected third-quarter results, but in reality shareholders have little to cheer.
When then-new CEO Antony Jenkins unveiled Project Transform in Feb 2013, prospects for Barclays looked good: apart from its core position in UK retail and commercial banking, it had a world-class investment bank thanks to Bob Diamond’s opportunistic acquisition of Lehman Brothers in the aftermath of the financial crash, together with top-quality franchises in the guise of Barclaycard and Barclays’ African businesses. Project Transform would eliminate the more egregious excesses of the investment bank, restore Barclays’ reputation, slash costs and non-core operations, and push return on equity (RoE) above the cost of capital.
21 months later the shares are down by over 25%, investment banking revenues have fallen off a cliff, the bank is still dogged by litigation for all manner of misbehaviour, and its capital adequacy remains in the balance with tomorrow’s announcement of the results of the Bank of England’s leverage test eagerly anticipated.
What went wrong?
Undoubtedly, the biggest problem has been the investment bank. Resurgent markets should have been good for business, but Barclays’s strengths lay predominantly in so-called FICC; fixed interest, commodities and currency. An unanticipated side-effect of QE has been to reduce the volatility that drives volumes in these markets.
But it also seems that Mr Jenkins — once dubbed Saint Antony — has not proved to be strong enough to manage fat-cat American investment bankers. Nefarious practices continued, such as the unresolved issue of ‘dark’ liquidity pools. Big-hitters called Mr Jenkins’ bluff over pay and bonuses, then promptly left anyway after receiving big payouts. The bank responded by cutting the investment bank further, even as some of it was walking out the door. The equities business, a potential future star performer, shrank by 25% in Q3. That’s value-destructive death-by-a-thousand-cuts: it would have been better to spin off the investment bank in the first place. Wrong business, or wrong management? I think some of both.
The upside
Two things did go right. The surprising boom in the UK economy helped retail and commercial banking: at bottom, banks are a play on the economies they serve. Cost-cutting has been successful with a 7% drop in expenses and a 7,800 headcount reduction — though this may owe more to hard-nut finance director Tushar Morzaria, whose investment banking background might also make him a promising candidate to succeed Mr Jenkins.
Together with good results from Barclaycard, retail and commercial banking contributed 53% of Barclays’ third-quarter core income and 60% of profit. That promises more stable and reliable income in the future, and with RoEs of 12.5% and 18.5% respectively, they should exceed the cost of capital. Barclays’ capital adequacy also looks better, reporting a 3.5% leverage ratio that augurs well for the Bank of England stress-test — but the proof of that pudding will be in the eating…
Cheap
Yet Barclays’ shares are still stuck at 0.8 x tangible net asset value — that’s cheap if RoE remain stable and there aren’t too many unanticipated litigation costs. So I’m holding on to my shares, admittedly with less conviction than before. They’re risky, but the upside is starting to look more plausible than the downside.