A Look At Barclays’ Revamped Strategy And Its Impact On The Bank’s Shares

On May 9, Barclays (NYSE:BCS) unveiled what is undoubtedly the biggest step by the U.K.-based banking group towards meeting the long term profitability and sustainability goals it laid out for itself last February, as a part of the ongoing group-wide reorganization plan dubbed ‘Project Transform.’ ^[1] The strategic update aims to make the bank “repositioned, simplified and rebalanced” by implementing sweeping changes to its business model – the most important being a substantial reduction in its investment banking operations as it moves from being trading-focused to origination-focused.

The revamp has been in the cards for quite some time now, as Barclays has struggled to churn out sizable returns in the wake of changing regulatory frameworks as well as legal issues. The new and leaner business model proposed by the bank clearly looks to focus on areas in which the bank has a strong presence, while trying to undo some of the damage its brand has suffered in recent years. As is evident from the 7.5% jump in the bank’s share price immediately after the plan was detailed last week, investors were quite happy with the announcement.

Below we detail the list of changes announced by Barclays as a part of the revamp, as well as the potential upside that could come from this program.

See our full analysis for Barclays’ stock

Understanding The New Business Structure

Barclays’ intentions with the reorganization are evident from the proposed changes to its business model. The new model marks a considerable change from the current operating structure, and consists of five divisions as compared to the older structure, which had six divisions. Things that stand out are the bank’s clear decision to focus on retail operations in the U.K. and Africa, which means that the bank will likely no longer pursue retail banking growth in other parts of Europe and Asia . As a major player in the credit card industry in the U.K. as well as U.S., Barclays decision to continue to prioritize its Barclaycard division is an important move as our analysis attributes more than 16% of the bank’s total value to its card business

Finally, while the investment bank will shrink over the next couple of years, the bank will house a little more than a quarter of its current risk-weighed assets (RWAs) under its non-core division, Barclays Non-Core (BNC). The BNC will divest non-core and non-profitable assets over the coming years – a move by Barclays along the lines of other banking giants like Citigroup, RBS and Credit Suisse.

Primary Goals At A Glance

The main targets that Barclays’ aims to achieve as a part of the proposed strategy by the end of 2016 include:

• Common Equity Tier 1 Ratio (Basel III fully-loaded):  >11.0% from 9.6% at the end of Q1 2014
• Leverage Ratio:  >4.0% from 3.3% at the end of Q1 2014
• Dividend Payout: Between 40-50%
• Return on average equity: At least 12% for the core business, and more than 9% at the group level (including non-core operations). The figure at the group level for 2013 was 1%.
• Operating Expenses: Around £14.5 billion ($24.5 billion) from an adjusted figure of nearly £20 billion ($33.7 billion) for full-year 2013

Implications of Capital Ratio & Dividend Payout Targets

Since the economic downturn of 2008, financial regulators have framed tighter rules for banks around the common equity Tier 1 ratio, which is why the metric is tracked closely by financial institutions as well as investors. Investors have been critical of the fact that Barclays has lagged behind several other global systemically important financial institutions (G-SIFIs) on this count – something that the bank addresses through its proposed fully-loaded Basel III common equity ratio target of 11% by the end of 2016.

Also, Barclays paid annual dividends of 6.5 pence (~11 cents) per share in 2013, which is just a fraction of the 34 pence (~57 cents) per share the bank handed out in 2008. The bank has not initiated any share repurchase plans since 2007 when it bought back shares worth £1.8 billion (~$3.6 billion in 2007 terms). It is therefore no surprise that the bank sets an explicit capital return target for 2016 with a payout ratio between 40-50%. The chart below captures Barclays’ payout ratio including share repurchases, and you can see how a higher or lower payout ratio affects the share price by making changes to this chart. It should be noted that the figure for 2013 is exaggerated (159%) because of poor net income figures reported by Barclays for the period.

Operating Expense Target Is Key To Achieving Other Goals

Clearly, Barclays’ dividend payout and return on equity goals depend on the bank’s ability to achieve stable operating profits over the next two years. As economic conditions in Europe are expected to remain soft at least in the short term, the best way for the bank to pursue improved profits is managing expenses. Barclays’ proposed goal of cutting down annual expenses to £14.5 billion ($24.5 billion) for 2016 entails a 25% reduction in operating costs compared to 2013 – an admittedly steep task.

A bulk of this reduction will come from the bank’s decision to considerably slash its fixed-income trading operations. These operations are responsible for more than a third (~35%) of the group’s total RWA while generating roughly 20% of its total revenues. As Barclays seeks to reduce its dependence on what was once a highly profitable unit, most of the 7,000 investment banking jobs that are to be trimmed by 2016 will be from the debt trading desk. The net effect of this decision will be two-fold: revenues from the investment banking division will be notably reduced, but expenses will be reduced in a larger proportion resulting in a net improvement in margins. Also, cutting down on these operations will help Barclays free a chunk of its capital tied up in this unit.

Although the impact of the job cuts will be seen most in investment banking operations, other operating units will also see a heavy reduction in headcount as Barclays works its way through no less than 19,000 jobs over the next two years. An important factor contributing to this is the bank’s decision to divest units moved to the non-core division. Also, the retail banking operations in Europe are expected to see job cuts as Barclays cuts back on the retail business in France, Spain and Italy. This move should help reduce the bank’s retail & business banking expenses in the long run as shown in the chart below.

It should be noted here that all these changes will entail additional expenses that Barclays will incur over the next two years. The bank estimates these “costs to achieve Transform” to be around £1.6 billion (~$2.7 billion) in 2014 and £0.5 billion (~0.8 billion) in 2015. Including all these factors in our analysis of Barclays, we estimate a 6.5% increase in the bank’s share value from $18 to $19. This is similar to the 7.5% jump in Barclays’ share price once the plan was announced.

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1. Barclays announces Group Strategy Update, Barclays News Releases, May 8 2014 [↩]