The UK’s perennially troubled banks have undergone something of a reputational makeover since the battle to tame inflation caused interest rates to spike. The monetary tightening cycle has significantly increased the sector’s net interest margins, meaning that banks are making serious money from their core activities for the first time since the 2008 financial crisis.
Bull points
- Favourable macro environment
- Compelling turnaround plan
- Successful UK retail business
- £10bn to be returned to shareholders
Bear points
- Poor track record
- Execution risk
Investors are showing cautious interest, with NatWest (NWG) earning admirers for its effective management, capital returns and rapidly shrinking government stake. Despite a shift in sentiment and improvements in profitability, however, UK banks still trade on an average price/earnings (PE) ratio of just six times.
Taking all the above into account suggests high income but vanishingly low growth for investors, and reflects a lingering wariness.
The temptation is to take the greatest income yield on offer with the least risk attached – and if you are an institutional investor, with a portfolio of pension funds that need cash to meet ongoing liabilities, this approach makes perfect sense. However, many retail investors will be more interested in combining both approaches.
It is necessary to ask, therefore, what true value is left in banks and whether further growth is likely.
One company that has the potential to improve its performance via management actions is Barclays (BARC), which has attracted plenty of interest this year as a result of its bold turnaround plan. Could the bank with the eagle logo finally soar?
Strategy shake-up
Barclays’ regulatory missteps over the past 15 years have lent regular excitement to results season. Whether it was over-issuing structured products in the US, resulting in a whopping fine, or messing around with Libor rates in the UK, or watching former executives face trial over fundraising secured from Qatar’s sovereign wealth fund in the aftermath of 2008 (all three were acquitted), the bank has rarely had a dull moment.
Many of the blunders arguably originated from a decision Barclays made in 2008 to boost its investment banking arm by acquiring the equities and corporate finance business of Lehman Brothers. The move from being a service provider to corporate clients to one with more skin in the markets was a big cultural shift which sat uneasily with the company’s quiet Quaker heritage.
The strategy has not paid off in the long run, with the investment bank’s good years easily cancelled out by runs of indifferent performance – as we are currently witnessing.
Earlier this year, management pledged to fix this and deliver a stable return on tangible equity (RotE) of 12 per cent by 2026, up from 9 per cent in 2023. Investors should be under no illusions that this is a considerable challenge that may require more action than management has currently announced. The root of the problem is that the investment bank consumes risk capital, but delivers proportionately less profit than the smaller UK retail business. Therefore, cutting the investment bank down to size is the key to making the turnaround plans stick.
There is certainly a great deal of market scepticism over whether management has either the will or the skill to undertake such a large restructuring. For example, if it is to meet its 12 per cent RoTE target, then an improvement plan must generate at least £1bn of savings.
Doubts are understandable given that Barclays has known for years that its investment bank was outsized, but has done little so far to reduce the share of risk-weighted assets devoted to the division. Its shares have languished in the meantime, having only perked up in the past couple of months.
To give management the benefit of the doubt, though, there are signs that it is making progress on reducing costs. In such a salary-intensive business, headcount reduction is the only way to make a significant dent in outgoings. To this end, Barclays cut 5,000 jobs in 2023, with a target of a further 2,000 redundancies this year, mainly in back-office roles in its UK bank business.
Significantly, however, “a few hundred” roles are reportedly being cut in the investment banking division. The savings target has also moved towards £2bn. In other words, the housekeeping needed to meet Barclays’ objectives is well under way.
Productivity improvements will also be crucial. Analysts at investment bank Jefferies forecast that investment banking revenues need to grow by £2.5bn between now and 2026, and revenue as a percentage of the investment bank’s total risk-weighted assets needs to rise to 6.9 per cent, up from the current 5.5 per cent. This assumes that risk-weighted assets stay static over the period at £197bn.
This would represent a major cultural shift for Barclays’ pampered investment bankers, who have traditionally not worried that much about the basic return that their activities generate. At the same time, the restriction of risk-weighted assets is essentially a limit on risks that can be taken. The promise to generate more with less has raised eyebrows, and probably means that management is making an assumption that corporate broking activity will recover enough over the next two years for the targets to be met.
Still, management appears to be doing what is in their power to do, and this should give the market a good deal more confidence in the shares. These already have a floor underneath them because of the £10bn capital buyback programme the bank has planned for the next three years, which makes it the biggest structural buyer of its own shares.
Cushy conditions
It is also clear from the first-quarter results season that the macroeconomic environment is still favourable for banks. Interest rates have yet to be cut, meaning that pressure experienced towards the end of last year on net interest margins has started to dissipate, with less churn seen in retail customer deposits. This year’s fall in profitability is set to be less extreme than originally feared, therefore, and Barclays and its peers are expected to comfortably meet their targets for 2024.
Jefferies currently has Barclays on a forward price/earnings ratio of under five times for 2025, with a dividend yield approaching 6 per cent. If Barclays is to narrow its discount to its main high-street rivals, then the improvement plan must deliver a consistent 12 per cent return on equity. Anything less and the market is unlikely to react well. One factor that may help this year and next is lower credit loss charges. Jefferies reckons that Barclays has overprovisioned for expected credit losses, which may be returned as spare capital once it is no longer needed to cover the balance sheet.
There is no question that Barclays has a chequered and troubled recent history, but the success of its UK retail business, which had the foresight to go big on mobile banking far earlier than its rivals, suggests that there is a core to the business that is profitable and competent. There is also the possibility that its US investment banking business will be consolidated and sold off, which would immediately help its return on tangible equity.
The discount to the sector and the dividends and buybacks on offer are substantial insurance premiums for investors while the bank attempts to move the dial on its operations to catch up with peers. It is undoubtedly a risk, but not an unbearable one at current levels.
| Company Details | Name | Mkt Cap | Price | 52-Wk Hi/Lo |
| Barclays (BARC) | £30.4bn | 202p | 208p / 128p | |
| Size/Debt | NAV per share* | Net Cash / Debt(-) | Net Debt / Ebitda | Op Cash/ Ebitda |
| 391p | £190bn | – | – |
| Valuation | Fwd PE (+12mths) | Fwd DY (+12mths) | FCF yld (+12mths) | CAPE |
| 6 | 4.4% | – | 16.1 | |
| Quality/ Growth | EBIT Margin | ROCE | 5yr Sales CAGR | 5yr EPS CAGR |
| – | – | 12.3% | 24.2% | |
| Forecasts/ Momentum | Fwd EPS grth NTM | Fwd EPS grth STM | 3-mth Mom | 3-mth Fwd EPS change% |
| 19% | 24% | 34.3% | 8.6% |
| Year End 31 Dec | Sales (£bn) | Profit before tax (£bn) | EPS (p) | DPS (p) |
| 2021 | 21.9 | 8,537 | 36.6 | 6.00 |
| 2022 | 25.0 | 7,731 | 30.8 | 7.22 |
| 2023 | 25.4 | 6,848 | 26.9 | 8.08 |
| f’cst 2024 | 25.9 | 7,348 | 31.1 | 8.58 |
| f’cst 2025 | 27.3 | 8,361 | 38.5 | 9.36 |
| chg (%) | +5 | +14 | +24 | +9 |
| Source: FactSet, adjusted PTP and EPS figures | ||||
| NTM = Next Twelve Months | ||||
| STM = Second Twelve Months (i.e. one year from now) | ||||
