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Barclays struggles to convince for the long term

Barclays struggles to convince for the long term
May 5, 2021
Barclays struggles to convince for the long term

Profits up, share price down. On the face of it, the initial market reaction to Barclays’ (BARC) first quarter numbers, didn’t tally with positive earnings momentum, especially given the brightening economic outlook.

Much of the earnings beat, net income for the period was £1.7bn versus £1.2bn forecast, was down to the release of provisions for bad loans. Going forward, however, the £8.8bn group impairment allowance is material.

Furthermore, until the Prudential Regulation Authority (PRA) is satisfied banks aren’t going to have to weather a storm of defaults in an uneven recovery, paying dividends is restricted.

Investors have long had to accept banks have their wings clipped by regulators. The real fly in the ointment was the rise in costs, up 10 per cent to £3.6bn, which serves to highlight the challenges for Barclays’ post-pandemic strategy.

Chief executive Jes Staley has sought to diversify revenue streams, championing investment banking in the face of investor activism. The approach has been somewhat vindicated, with the division contributing £1.75bn earnings to overall performance, but that in itself brings complications.

One factor that will put upward pressure on Barclays’ cost-to-income (the ratio of costs to profits), which is now reported at 65 per cent, is the budgeting of a bigger bonus pool for investment bankers. The perception of pouring out a saucer of cream for the fat cats is dangerous, especially if further down the line households and small businesses are struggling.

The PRA has been clear since the outset of the crisis where it stands on compensation, adding a few lines on the matter as part of its wider edict on banks’ use of their capital:

“The PRA will scrutinise proposed pay-outs closely to ensure large banks have applied the PRA’s rigorous remuneration regime in an appropriate fashion.”

Even with a more upbeat prognosis for the UK economy, it might annoy patient shareholders to see Barclays richly reward some staff if the PRA is still insisting on dividend restraint.  It’s quite the tightrope to walk, and another aspect of investment banking has been highly contentious in the run-up to the annual general meeting on 5 May 2021.

Out of 29 resolutions to be voted on at the AGM, the one that Barclays’ chair Nigel Higgins implored investors to reject was on climate change. Activist NGO Market Forces have dismissed Barclays’ moves to meet its target of being a ‘net zero carbon bank by 2050’ as inadequate.

Unconvinced by Barclays’ bespoke BlueTrack methodology, MarketForces is pressing the bank to completely phase out funding of fossil fuels in a timeframe consistent with the Paris Agreement targets. That includes an end to project finance, corporate finance and underwriting.

They point out that in the first four years since Paris, Barclays has been Europe’s largest fossil fuel financier and the world’s seventh largest, thanks to $118.11bn funding arranged for coal, oil and gas.

Tension between meeting climate obligations and making a profit will be a theme for many businesses and that’s the rub for Barclays when retail banking is beset with difficulties. It has drawn criticism from Market Forces for $24.58bn of fossil fuels financing between January and September 2020 – an increase on the equivalent period the previous year.

Of course, there has been a pandemic and energy companies were drawing down credit lines and raising finance wherever they could. From the bank’s perspective, making money advising on capital market actions was helpful given the talk of negative interest rates last year.

Impetus to turn down bad business is gathering, however. Which is another reason to ask whether it is worth investing in Barclays. BlueTrack is about controlling the narrative on ESG scoring, which could yet push up Barclays’ own cost of capital.

There is a value argument for the shares. The bank is priced at less than 0.7 times its tangible net asset value, so is hardly an expensive play on the global economic recovery.

The trouble is, what shape is that recovery going to take and is Barclays too exposed to activities caught in the transition? Then there is the question of time. How soon will the regulators be happy that the retail and small business lending operations are healthy enough to slacken the reins on dividends?   

The tier one capital ratio, the proportion of high-quality capital reserves, is cause for optimism at 14.6 per cent. But the long-term investment case will rest on more than getting through the next few months of impairment risk.

Upward pressure on rates is positive for net interest income, the profit from lending, but restructuring the retail business, including a huge review of property assets and branches, is a cost that can eat into the overall return on equity for shareholders. Ultimately, Barclays' shares are still cheap because there are so many uncertain variables.