Category Archives: Barclays

An Open Letter to Barclays Management

Dear Mr. Staley, & Mr. McFarlane,

Firstly, I would like to congratulate the bank on the recent results reported for year-end 2016, and Q1 2017. The transformation we’ve seen at Barclays in such a short time-frame from when Mr. Staley took the CEO position in October 2015 has been most satisfactory. While significant challenges remain ahead, we are now on a clear path towards high quality and sustainable earnings. For that I feel that you must be commended for your efforts. However, I am not writing this letter solely to congratulate the team on this, I am writing as an individual shareholder with a specific view on capital allocation going forward.

I noted with particular interest that the Terms of Separation with Barclays Africa had been signed on the 31st of May 2017. I feel that this marks a watershed moment for Mr. Staley and  the current management team. Not only does it signal the de-consolidation of Barclays Africa from the Barclays balance sheet, but it also raises the CET1 capital ratio well in excess of the target set down in 2016. If my understanding of the present situation is correct, then the de-consolidation of the African business now puts Barclays within the 13.2%-13.3% range of CET1 capital ratio, well in excess of the 12.3%-12.8% range specified as required by Mr. Staley in March 2016. I believe the opportunity now exists to shrewdly use this extra capital to generate an outstanding return for shareholders.

“Any management of a bank that is trading below its book value can’t sleep at night,”

Mr. Staley made the above statement on March of 2016, and while it is true that the differential between the share price and book value has closed somewhat since this comment was made, it remains and is still significant. As I write this letter, the Barclays share price stands at £2.11 (June 2nd 2017 close), a discount of just under 28% to tangible book value of £2.92. I certainly recognise management’s priority isn’t with the short-term fluctuations of the share price. However, I do think in certain circumstances, questions must be asked when such a clear discount persists over an extended period of time, as is the case with Barclays. Clearly the market is signalling only one outcome here; namely that Barclays is a mediocre business, and thus deserving of such a discount. If you are to believe as I do that this is not the case, that Barclays will have a future that is more glorious than its recent past, then now is the time to consider how we can maximise our investment today in order to deliver a superior return tomorrow. I feel that with some excess capital now available, a compelling opportunity now presents itself.

When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the marketplace, no alternative action can benefit shareholders as surely as repurchases.

Warren Buffett wrote the above in his 1984 letter to Berkshire Hathaway shareholders and I believe what he wrote couldn’t be more true for Barclays at this moment of time. With our bank now trading at a significant discount to tangible book, a stock repurchase plan now looks incredibly accretive to investors on a per-share basis.

As of the last Q1 2017 report, Barclays reported the following numbers.

  • RWA £361bn
  • CET1 ratio 12.5%
  • Share count 17.03bn

If we were to propose a stock buy-back of 850m shares and acquired them at the current £2.11 stock price, I estimate the numbers end up as below.

  • RWA £340bn
  • CET1 ratio 12.8%
  • Share count 16.2bn

As you can see CET1 ratio stays at the upper-end of management’s guidelines. However, book value and earnings per share increases in an accretive manner to shareholders, thanks to the fact we are purchasing well below book value. As the bank grows into the future, returns should compound as the growing numerator of earnings will be upon a shrunken denominator that is the share count.

Last year you took the brave step in cutting the dividend last year because you knew it was the cheapest way of raising capital and generating long-term shareholder returns. Going forward, as we start to create surplus capital on the balance sheet, I would urge you to consider the benefits of a stock buy-back, particularly while it trades below tangible book value.

Kind regards,
Tabhair.

Barclays PLC – Q2 2016 Results Reaction

Barclays PLC – LON:BARC
Share Price – £1.56
Market cap – £26.8bn

Barclays announced Q2 results yesterday and broadly speaking my expectations were met, with management meeting their own guidance.

  • Core RoTE of 11%
  • CET1 ratio increased to 11.6%
  • Tangible book value up to £2.89
  • Cost/income ratio down to 65%

With the share price still near 52 week lows, it seems the market as a whole isn’t convinced at the turnaround. For me, the market still has an overly pessimistic view of Barclays. Management are 1/4 of the way through their restructuring plan, and are on track to meet their targets. Vigilance is required though, as my original estimate for roughly £5bn in core earnings in a clean year has slipped slightly to about £4.7bn. For now, I am happy to take advantage of the volatility in the market to buy stock at around a 50% discount to tangible book value.

Barclays PLC – Q1 2016 Results Reaction

Barclays PLC – LON:BARC
Share Price – £1.71
Market cap – £28.8bn

Barclays reported Q1 results on Wednesday. Broadly speaking, the results met my expectations with the two year turnaround being on-track, and maybe even slightly ahead of my expectations at this point.

  • Return on equity for core operations 10.7%.
  • CET1 ratio dipped slightly to 11.3%.
  • Non-core wind-down continues as expected.
  • Expenses increased a little ahead this quarter.
  • Tangible book value up to 286p (from 275p).

Business operations

Barclaycard continues to be the star performer of the business, Barclays have made an acquisition in this area, buying the JetBlue card portfolio. Hopefully this is a nice bolt-on acquisition that makes sense. UK retail had a solid performance in the quarter, very little change to see here. Investment banking performance was mediocre, but did well in comparison to competitors. Management continue to be quietly confident on this front. I suppose being investment bankers at heart they are bound to be. Non-core was worse than expected with nearly have the loss from non-core generated by one item.

As expected, loss before tax increased to £815m, driven mostly by a fair value loss of £374m on ESHLA (Q415: loss of £156m)

This blow-out initially worried me a lot. Thankfully, on the conference call, the nature of the ESHLA loans was explained and how we could see future impacts on this portfolio.

Yes, so to step back, what goes on here is we have a portfolio of fixed rate loans that are marked to market using gilts rates, and then are hedged with interest rate swaps, so that package is exposed to movement in the gilt asset swap spread … if the spread doesn’t move literally at all over the full three months of a quarter, you see virtually no P&L necessarily coming through there

Management also said that the spreads on this portfolio have come in a bit since these numbers, so the problem hasn’t gotten any worse, and it may actually get better next quarter.

It also sounds like the Brexit vote could be having an impact here.

And the second thing is, of course, swap spreads will move around, and I think with the Brexit vote around June 23rd, it’ll be very hard to [predict]. You can make persuasive arguments that they could tighten a lot from here, or they could widen again. And we’ll manage through that.

Final thoughts

One of the points I did not touch was the disposal of Barclays Africa, which picked up pace in the last week with multiple parties submitting their interest. This is good news, as it should mean that the bank can realise close to full market value for this disposal. I am also hoping that they will have a tax trick up their sleeves in order to realise most of the gain on this disposal.

The question of dividends was also raised on the call a number of times. Management refused to be drawn on anything beyond the stated expectation that they would not be fully restored until 2018. I believe that management may be purposely under-promising here. If Barclays Africa is able to be fully de-consolidated this year, then my rough numbers suggest that the CET1 requirement can be met by the end of this year. By 2016 year-end, I could see about 70-80% of the restructuring being complete. I wonder at that point, will they consider rewarding patient shareholders with some sort of special dividend on 2017?

Overall, I am happy enough with the results. I can understand a lot of the investor scepticism around Barclays. It’s very easy for a company to bundle all the money losing parts of the company into a non-core business line and tell investors that they are no longer relevant to reported results. What’s important here though is that Barclays are making a concerted effort to streamline the business into core profitable segments. For now, I will be continuing to hold, and I may look at buying in again should the share price below my initial cost position in this quarter.

Barclays PLC – Misunderstood And Sold Far Below Tangible Assets

Introduction

Barclays PLC – LON:BARC
Share Price – £1.50
Market cap – £25.35bn

Eight years on from the financial crash of 2008, the fallout across the financial sector is still being felt. No more is this evident then at Barclays PLC. After years of restructuring, CEO Jes Staley announced yet another re-organisation with the bank being stripped down to profitable core operations, while also announcing a dividend cut to raise capital. The reaction from long suffering shareholders was sharply negative to the proposed two year plan. Particular ire was directed towards the investment bankers, who endured only a 10% cut to bonuses, as opposed to shareholders who had the dividend cut by over 50%. Shares moved down to 52 week lows, with the bank now trading at share price of £1.50 as of this posting, off of tangible book value of £2.75. The market has clearly lost patience with Barclays and their turnaround. However I believe that bank now trades at a sufficient discount relative to peers even at today’s depressed valuations. I also feel that the substantial discount to tangible book value provides a margin of safety.

Even before the latest restructuring was announced, the Barclays of 2015 had already underwent significant change since the crisis. Legislation has forced Barclays to ring-fence the retail operation from investment banking, the wealth management operation was sold to raise capital, and already the first steps were made to withdraw from non-profitable Asian/European markets. The latest plan accelerates further change, focusing the company around three specific business lines, Retail and Corporate, Barclaycard, and Investment Banking. The African operation is to be sold, with remaining non-core areas to be sold or put into run-off. A sum of the parts examination however, reveals that the underlying businesses that the company are looking to focus on, are priced at a discount when compared to competitors operating even in today’s poor banking environment.

Barclaycard

barclaycard finances

Undoubtedly the jewel in the crown of the company at the moment. While not the most profitable part of the business on an absolute level; in terms of cost ratio’s, net interest rate margin, and return on equity – Barclaycard is the best part of the business. If you were to apply Capital One’s current PE to this chunk of the business, you’d have Barclaycard being valued at £11bn just by itself.

Retail and Corporate

barclay retail corporate

By far, the largest part of the Barclays business is the Personal and Corporate operation. Costs are higher, margins are lower and returns on equity are also lower than Barclaycard, but still at a level that will provide a decent return for investors. If the Lloyds valuation is anything to go by, then a multiple of 6x pre-tax/impairment earnings is a reasonable price for this business – giving a valuation of £18bn. Please note, that the combined value of Barclaycard and the Retail/Corporate operations using competitors as a comparison exceeds the current market cap by nearly 20%. In this case, you really are getting the investment banking part of the business for free.

Investment Banking

barclay investment banking

Investment banking is currently in a cyclical decline with all competitors facing significant challenges. If it’s bad in the US, the situation is even worse in Europe where the likes of Deutsche Bank and Credit Suisse have struggled badly in the last year. If you were to value this part of the business at just 8x after-tax earnings, it gives a bargain basement valuation of £6.4bn. The optimist in me would like to think that at some point in the future, animal spirits will run free and corporate financing activities will be required again. Until then, at least we’re getting the business for free.

Barclays Africa

No longer relevant to the investment thesis as this is to be sold with management giving guidance of £3-4bn for the sale.

Non-core/run-off

Currently running at negative £1-1.5bn. The vast bulk of the original £400bn of leveraged non-core assets has been reduced to £120bn and falling. By 2017 the bulk of the non-core operation run-down should be complete.

Management

Current chairman John McFarlane has a reputation of being a ruthless turnaround expert, having re-organised Aviva, which subsequently managed to emerge after a wobble a few years back. His appointee to the CEO role is an ex-JP Morgan investment banker in Jes Staley who was given a mandate to accelerate the turnaround plan.

While investors have reacted negatively to the dividend cut, for me, the cut has shown good judgement on behalf of management. Capital requirements have to be met, and for Barclays to do so requires either assets be sold at rock bottom prices, equity to be raised (major dilution), or the dividend to be cut. A temporary dividend cut is undoubtedly the best of some bad options. Paring back to the core profitable operations also makes sense (Barclay card, UK retail and corporate are both extremely good businesses). I can see why Staley is willing to persevere with Investment Banking. The sector in Europe especially is currently in a downturn (Deutsche Bank and Credit Suisse are also feeling the pinch), and for Barclays to sell the company, or withdraw from a declining market could be selling the business at a low. I cannot say when, but at some point, demand for investing banking services will pick up. What’s not clear is the sale of the African bank – it makes little sense to me that they would sell a business that makes £1bn for between £3bn-£4bn. My worry is that we’re selling something that we know is profitable in the here and now to keep something else that only promises a return to decent profitability.

Overall

It’s understandable why Barclays has been the laggard in UK banking over the last year. When a competitor (Lloyds) are increasing dividends and reaching the end of restructuring plans, it’s not surprising that frustrated investors in Barclays have been throwing in the towel after having their dividend cut, with yet another restructuring plan put into place. A sum of the part analysis reveals that the core of Barclays operations are good businesses (worth at least £2.00) and I believe that if the patient investor is willing to wait, the shackles of the under-performing non-core business will be thrown off, allowing full value of the business to be recognised. What’s more – my valuation model also provides a free option on the investment banking side of the business. It’s impossible when/if investment banking will be turned around, but it’s not relevant to the thesis, and would be the icing on the cake.

Possible catalysts for value creation

  • An increase in the dividend/share buy back. In a decent year, a striped down and restructured Barclays should be able to post about £5bn worth of earnings after tax based on 2015 figures (retail/corporate doing well, investment doing poorly). Assuming a 40% payout, investors could start expecting a dividend of 12p for the full-year of 2017, giving a yield of 8.5% based on the current share price of £1.60. Assuming that transpires, the dividend investors are likely to return to Barclays. If the Lloyds current dividend yield is anything to go by, you have a three year time-frame for the doubling of the share price.
  • Splitting the retail and investment banking operations into two separate companies. The British retail side of the Barclays business has shown strong underlying strength. The investment banking arm on the other hand has generated sub-par returns on capital. Splitting the company would allow the full value of the retail operation to be realised.
  • A free option on investment banking operation. Given that Barclaycard and Retail and Corporate banking are already priced at a discount. The market is giving no value to Investment banking side. I can understand why Jes Staley has decided to keep the faith with investment banking. This is understandable, as the investment banking related activity in Europe has been down sharply over the last year.

Risks

  • Exceptional items have proven to be less than exceptional over the last few years (mis-selling fines, LIBOR-fixing fines, etc.).
  • A downturn in the UK economy would have a very negative impact of the company as the company is now more heavily exposed to the UK.
  • My model expects non-core run-off losses continue along the same lines as we’ve seen in previous years.
  • Leverage ratio of the bank is 4.5%, which is higher than peers and exposes the bank to more catastrophic risk.