Sherborne Investors fired its arrow at Barclays this morning. While it may not have inflected a mortal wound, there's a distinct hissing sound as some of the hot air spoken about the UK bank leaks from the resulting hole in its defences.
Sherborne's argument is set out in a letter to Barclays' shareholders which is intended to make the case for Sherborne owner Edward Bramson to take a seat on Barclays' board. Bramson's detailed attack is set out below. Firstly, however, it's worth recalling Staley's own pitch to Barclays' shareholders when he joined as CEO in 2016.
Staley's strategy was elaborated in a presentation he made to shareholders at the time of Barclays' fourth quarter results for 2015. It was here that Staley first outlined his vision for a transatlantic investment bank, that he rejected cuts to risk weighted assets (RWAs) allocated to the investment bank, and that he - crucially - insisted that the return on equity in Barclays' investment bank had to rise above the cost of equity because.... Well, just because.
"You cannot have global capital markets with the intermediate industry generating returns below the cost of capital - it's not sustainable," said Staley in 2016, without elaborating how or why the necessary correction would take place.
It's this point in particular that Bramson seems determined to Skewer Staley on.
The Return on Tangible Equity (RoTE) at Barclays investment bank
The chart below, based on figures provided by Sherborne in its letter, highlights the problem. Deutsche Bank aside, the RoTE at Barclays' coprorate and investment bank is exceptionally low. And contrary to Staley's hopeful assumption three years ago, Sherborne contends there's no real reason for it to get any better.
As outlined by Sherborne, Barclays' problem is all too common - and will be familiar to Goldman Sachs: it's got the wrong clients.
If you want to generate returns as an investment bank now, Sherborne says you need corporate clients who will engage in transaction banking, securities services and corporate lending. What Sherborne says you don't need are: '"Buy Side" customers, such as hedge funds and private equity firms, which provide lower revenue yields.'
Unfortunately, these are precisely the clients Sherborne says Barclays has. The implication is that Staley has been chasing the wrong clients in the wrong businesses in the mistaken belief that returns will naturally gravitate to a level that makes sense. They won't.
"The strategy is unrealistic as, despite the addition of more and more assets, revenues have actually fallen since 2015, as the decline in yield has outpaced the increase in activity," says Sherborne.
In Staley's defence, the return on tangible equity at Barclays' corporate and investment bank has increased substantially during his tenure. In the third quarter of 2014 it was only 3.3%, and by the third quarter of 2018 it was 6.6%.
Also in Staley's defence, Barclays has 53 UK corporate broking clients whose business feeds through to its investment bank. - It's therefore not the case that corporate clients have been neglected altogether.
Bramson, however, would clearly argue that this isn't enough. At 6.6% or even 7.1% (in the chart above), the return on tangible equity (RoTE) in Barclays' corporate and investment bank (CIB) still isn't covering its cost of equity of around 8.7%. This is why Bramson sees no reason to devote any additional capital to the CIB as it will be, "almost certain to cause an immediate destruction of shareholder value, as it would be valued in the market at significantly less than the amount invested in it."
Worse, Bramson highlights the potential for Barclays' cost of capital to rise and for the returns gap to widen further still. He points out that Moody's currently rates Barclays Baa3 - one notch above junk. If and when Moody's decides to downgrade Barclays again, the capital-intensive fixed income trading activities of Barclays' CIB will be more uneconomic still.
So, what does Staley intend to do about that? Sherborne is right to point out that wishful thinking may not be enough.
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