Transforming Project Transform
Barclays’ Transform plan needs urgent transformation. Chief Executive Antony Jenkins’ year-old strategy to revamp the UK lender is already struggling. First, the Bank of England jacked up gross equity-to-assets requirements last summer, necessitating a scrambled 5.8 billion pound rights issue and a one-year delay to the bank’s 12 percent return-on-equity target. Then Jenkins reneged on an assumed policy of reining in pay – and justified it with a decidedly pre-crunch declaration of needing to pay up to retain talent.
Jenkins could just exit investment banking, and turn Barclays into a retail bank. But the lender has a competitive advantage in the capital markets business and few investors really want another Lloyds. Shareholders are most concerned about Barclays’ investment bank delivering returns below the cost of capital, and historically relying too heavily on leverage. Return on assets in the investment bank averaged around 25 basis points over the last decade, barely half that of some of its U.S. rivals, according to UBS. Last year, the investment bank may have produced 38 percent of group revenue, but it ate up half of the UK lender’s risk-weighted assets and two-thirds of its gross assets.
Jenkins needs to be brutal with businesses he doesn’t need. And he needs to defend vigorously what remains.
Returning unacceptable numbers
From 2016 onwards, Barclays expects to be operating with a Basel III common equity ratio of about 12 percent and a gross equity-to-assets position of 3.5 percent or more, against 9.3 percent and 3 percent now. Yet investment bank return on equity (ROE) was only 8.2 percent on a 10.5 percent Basel risk-weighted basis in 2013.
Barclays could just pray that revenue snaps back. But the top line would have to grow 9 percent from 2013 levels to enable a 12 percent ROE, on Breakingviews’ calculations. Controlling costs is a surer way of delivering value for shareholders.
How much does Jenkins need to hack back? Barclays is already shedding about 650 million pounds of non-personnel costs and 300 senior investment bankers, according to a person familiar with the situation. But pay is still the big drag on earnings. Assuming those earmarked for redundancy are paid an average 1 million pounds, another 3,500 investment bank staff, or about 14 percent of its compensation bill, would have to depart – assuming no further improvement in leverage.
Jenkins then has to work out which bits to cut. Barclays’ historic strength has been in fixed income, currencies and commodities (FICC), which accounted for 52 percent of investment banking revenue last year. But its homegrown regulatory headaches and a cyclical downturn have caused Barclays to lose more FICC market share than most competitors. Fixed income is especially consumptive when it comes to capital: at UBS, which ditched much of FICC in 2012, it amounted to two-thirds of investment banking RWAs. Meanwhile, Barclays’ equities and advisory businesses, buoyed by the 2008 acquisition of Lehman Brothers in the Americas, are growing revenue.
Some parts of FICC should stay as they are: the UK bank is a top-three player in foreign exchange trading, rates and some areas of credit, according to Citi and Greenwich Associates. But Barclays is weaker in commodities and emerging markets, and firmly in the second tier for securitisation and structured credit. It could cut back in those business lines further.
Delivering these changes will help the final problem: pay. In 2013, the compensation-to-income ratio was 43 percent, 4 percent above the previous year. Shedding 3,500 investment bankers should whittle the compensation ratio down to its long-term 35 percent target.
Yet Jenkins needs to change his message too. In a recent interview he seemed too in fear of truculent investment bankers leaving. Instead, he should unashamedly link bonuses far more closely to economic returns: if those in underperforming divisions leave, that’s a help not a hindrance. The flipside is that he should aggressively back his bankers’ right to be highly paid when they do make returns above the cost of capital. Valuable staff will stick around through the bad times if they believe in the future of the franchise.
The final piece of the jigsaw is a strong chairman with considerable investment banking experience to replace David Walker, who retires next year. Barclays’ investment bank is still worth championing. But only with a more finely tuned division can Jenkins ever hope to instill pride in his bankers while also keeping their pay in check.