Barclays Plc Full Year Update – 16 April 2015
In the 324 years since Barclays was founded as a goldsmith’s bank, on Lombard Street in London, it has grown to become the UK’s second largest financial institution with approximately £1.36 trillion in assets.
The modern day business is split across four divisions, Personal and Corporate Banking, Barclaycard, Africa and Investment Banking. The bank operates a significant retail branch network and employs 140,000 people worldwide.
|Index||FTSE 100||Ticker||BARC.L||Latest Close||260.35|
|52 Week High||269.94||52 Week Low||201.75||P/E (F)||10.5|
|Dividend Yield %||2.55||Dividend Cover||N/A||CEO:||Anthony Jenkins|
|CFO:||Tushar Morzaria||Previous Price Target||190.00||Current Price Target||190.00|
Barclays shares pare losses in late 2014
After a torrid 18 months Barclays shares finally appeared to bottom out (201.00 pence) during the summer of 2014, a short distance above our price target of 190.00 pence, before beginning to pare losses in the second half.
Key to the group’s better performance has been its emergence unscathed from the other side of a gauntlet of bank stress tests that were held throughout the course of 2014.
Consensus expectations heading into the tests were for Barclays to achieve a narrow pass as it was believed to have among the narrowest of capital buffers guard against future crisis after paying a number of heavy fines during recent years.
However, the bank passed European stress tests with flying colours before later sailing through Bank of England stress tests in December. This set the shares up for a strong rally into the new year as the group’s full year reporting date in March approached.
Today we review both the full year financial performance at Barclays as well as an overview of what we believe are the key risks facing what has been throughout much of the last few year, a beleaguered UK banking sector.
Barclays Plc Share Price / Weekly Intervals
Barclays full year financial review
While management provide lots of attractive “adjusted” and “underlying” figures for the bank’s 2014 performance in the full year results presentation, we skip straight to the financial statements at the back to get a clear idea of the group’s actual performance in real terms and real money figures.
Looking at the top line the all important net interest income came in 4% higher for the year, largely as a result of increased profitability within the retail bank. Although, total income and net operating income were both lower for the period, with each falling by 9.2% and 7.0% respectively.
On the expenses front staff costs were down by 9.5% for the period, while admin and expense costs were also some 4% lower for the year. This means that total operating expenses were down by 7% for the period, which is positive.
However, this progress in terms of costs was not sufficient enough to offset lower income and higher regulatory provisions for the period as when we get down to the bone, post tax profits from all continuing operations were lower by 34% at £845 million,
Furthermore, after the group’s actual earnings of £845 million were divided up between the various classes of investors in Barclays securities, each with a different place in the pecking order, ordinary shareholders were actually left sitting on a loss of £174 million for the period.
This equates to a per share loss of 0.7 pence, which means that the £1 billion paid out in dividends to ordinary shareholders for the period will have had to come from reserves.
The upshot of this result is that if the group is to maintain the current level of cash returns to shareholders over the medium term it will urgently need to address its cost base, as well as do all it can to minimise the need to make further provisions for regulatory redress in future periods.
An overview of key risks for the UK Banking Sector in 2015 and beyond:
Looking ahead we see a number of key risks for the sector as a whole, which are A) Conduct & Litigation Risk, B) Political Risk, C) Interest Rate Risk and D) Regulatory Risk.
In the grand scheme of things the greatest threat to the banking sector over the near to medium term is still the issue of past conduct and the consequent litigation risk.
While the headlines detailing the wayward past behaviour of banking organisations have subsided to a degree during recent months, there remains a number of ongoing investigations which could still result in big fines for the sector.
In this regard we note that when reporting full year results, Barclays actually increased its annual provision for regulatory redress in the coming months by 15%, bringing the total amount set aside in 2014 to £2.36 billion (£2 billion in 2013).
Conduct and regulatory redress – Why £4.2 billion in provisions may not be enough
The key conduct issues facing Barclays at the moment relates to FX markets after the group pulled out of a syndicated settlement with regulators when it emerged that the proposed fines would not be full and final, meaning that other regulators would still be free to pursue further settlements over the same actions at a later date.
The bank currently has £4.2 billion in provisions for redress on its balance sheet however, FX is a big issue for Barclays as conduct in this area is still being investigated by the FCA in the UK, as well as a whole host of regulators in the US including the Federal Reserve.
In addition to FX there are also multiple investigations still taking place over the packaging and sale of US mortgages backed securities during the run up to the financial crisis. While this is expected to cost RBS up to £6 billion in additional fines, it is not yet clear to what extent it could affect Barclays.
The only thing that is certain is that past conduct issues remain a very live and costly issue for Barclays at present and for this reason, we believe it is highly likely that the bank could once again be forced to make further provisions for redress in 2015.
Setting litigation risk aside and looking to the immediate future we see political risk as the most pressing for UK banks, as the sector is an easy target in the run up to the general election, although we note that the impact of political rhetoric upon banking shares has been limited so far.
Despite this, we still caution against excessive optimism for the time being as in a post election world the sector could still present as an easy target for any new Labour/SNP coalition government that may come to power, particularly in the event that it finds itself under pressure to score points with an uneasy electorate.
Interest rate risk
Interest rate increases could be both a blessing and a curse. On the one hand banking groups like Barclays, with large investment and trading operations, will benefit from increased volatility in financial markets, while its retail operations should also benefit from a higher net interest margin.
However, on the downside the stretched state of consumer finances in the UK could mean that when interest rates go up, the number of defaults and non performing loans could also increase. This would be negative for earnings.
Further regulatory risk
Last but not least, with last year’s wave of stress tests now out of the way, the road ahead in terms of capital requirements is somewhat clearer for UK and European banks.
However, new regulation is still a major issue for the sector and with a number of new supervisors (SRB, ECB, new EU commission) set to become active in Europe this year, there remains a threat that new regulatory diktats continue to undermine bank financial performances and the ability of management teams to focus on increasing returns for shareholders.
On a positive note the group return on average tangible equity was higher for 2014, at 15.8% (12.7% in 2013), while the overall cost / income ratio was lower at 62% (68% in 2013). The group also improved its score across a range of regulatory leverage ratios however, from a balance sheet perspective, none of this changes the fact that Barclays remained highly leveraged in 2014.
In our view, the situation surrounding gearing is unlikely to change for the better by any notable degree in the near to medium term, although this isn’t the end of the world if the group is able to continue to meet regulatory leverage and capital requirements.
In terms of dividends the group paid a total of 6.5 pence per share to investors for 2014, which equates to a yield of 2.5%. This was paid largely from Barclays reserves as ordinary shareholders at the bank actually
While management state that the group achieved earnings per share of 17.3 pence for the year this is actually an incredibly misleading statement. We say this because after the group’s real terms earnings of £845 million were divided up between the various classes of investors in Barclays securities, each with a different place in the pecking order, ordinary shareholders were actually left sitting on a loss of £174 million for the period.
This equates to a per share loss of 0.7 pence, which is the reason for why we do not provide a dividend cover ratio with today’s analysis, because the £1 billion paid out in dividends to ordinary shareholders was paid largely out of reserves.
From a valuation perspective it is difficult to call it for Barclays at the moment, given the level of uncertainty that pervades over the UK political environment and the future outlook for regulatory fines.
At just 10.5X consensus estimates for 2015 EPS and 14.6X 2014 EPS the group appears, on the surface, to be trading at a slight discount to the sector average of 16X.
However, given the impact that recent and future fines have had upon the group’s earnings and its ability to pay dividends, the discount is probably warranted at present.
Looking ahead, Barclays will need to address its cost base while doing all that it can to minimise the potential for further fines to eat into future earnings. In the interim, we prefer to await further information on the likely scale of liabilities stemming from the FX rigging investigations before making any changes to our valuation assessment.
While we are still concerned over management’s persistent decimation of the investment bank, there are more pressing issues that we believe Barclays shareholders should be focusing on at present.
In the immediate future the general election in the UK is a significant source of uncertainty for the banking sector as a whole while, once past the months of May and June, past conduct issues and the potential for further fines will likely resume their place as the most prominent issue for the sector.
This is particularly important for Barclays as if it were not for the £2.3 billion provision set aside from 2014 earnings, the group will have been able to fund its dividend payments for the year from its 2014 result. However, due to the provisions, Barclays dividend for ordinary shareholders was funded largely by reserves.
For this reason the outcome of ongoing investigations into past conduct at Barclays, particularly in FX, will be the single biggest factor affecting our expectations for the shares over the medium term.
If total fines for the FX scandal et al arrive to be less than what the bank has set aside in provisions (£4.2 billion) then the current payout will be safe and moreover, the medium to longer term scope for dividend growth at the group would almost certainly command a much higher valuation.
Such an event would also prompt a reassessment and upgrade of our price target for the shares.
However, the current level of uncertainty over the bank’s future liabilities is just too high and for this reason, we prefer to await further information regarding the outcomes of current regulatory investigations before altering our price target or general guidance for the shares.
The next scheduled event of note for Barclays is the release of the Q1 Interim Management statement on 29 April.
The contents of this report and the Stockatonia website (https://www.stockatonia.co.uk/