What Barclays’ (LSE: BARC) shareholders wouldn’t give to return to the halcyon days of 2007 when booming profits from the investment bank, asset management arm and even boring old retail banking sent share prices to their peak of 790p.
With shares now trading at less than a quarter of that, is there any chance of their returning to pre-Financial Crisis levels?
On one hand, bulls can point to a 0.45 price/book ratio as evidence that Barclays’ assets, if fully valued by the market, could send shares soaring to around 380p.The bad news is that there are valid reasons why the market is so heavily discounting shares of the mega bank.
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Most critically, profitability is well below pre-crisis levels. Barclays’ return on equity (RoE), the most popular way to measure banks’ profitability, was 24.7% in 2006 and 20.3% in 2007. By comparison, full year 2015 RoE was a relatively tiny 4.9%.
The now question becomes whether the bank can ever responsibly juice operations enough to return to earlier levels of profitability. You’ll be hard pressed to find analysts who believe this is possible. Many reasons exist, but it mainly comes down to regulators demanding higher capital buffers meaning more money socked away earning next to nothing, lower profits from investment banking arms, increased compliance requirements meaning soaring operating costs, and low interest rates crimping margins for loan operations.
Of course, even if Barclays can’t viably expect to return to peak RoE, the bank could target higher revenue as a means of returning to bumper overall profits. Bad news on that front as well as post-crisis acquisitions, including Lehman Brothers’ North American assets, have led to revenue that’s already higher than pre-crisis levels. And with the bank pushing ahead with plans to divest its sprawling African retail bank, group revenue will be shrinking considerably in the coming years.
Solid enough?
But perhaps it’s unfair to expect Barclays shares to return to their pre-crisis peaks since no major global banks outside of America have been able to achieve this target. If we forget that metric, is Barclays at least solid enough to merit a closer look from investors?
I don’t think so. Barclays’ profitability over the past few years has relied heavily on strong UK retail banking and transatlantic credit card operations. These are great assets, but low interest rates hitting net interest margin and the possibility of an economic slowdown post-Brexit should remind investors of the highly cyclical nature of retail banking.
Second, the £46.7bn of bad assets still on the books years after the Financial Crisis will be weighing down profits for years to come. While the bank disposed of £8bn of these non-core assets over the past half-year, they still contributed £1.49bn in losses in the period.
Add in a massive investment bank whose RoE fell from 9.8% to 8.4% year-on-year over the past six months and it’s easy to understand why strong results from relatively boring retail banking are consistently overshadowed.
To top it all off, while cash raised from the potential sale of African assets could conceivably be returned to shareholders, the company’s recent 50% slashing of its dividend is sufficient proof for me that the bank is worried enough about capital buffers that dividends won’t be substantial anytime soon.
