RPT-Fitch: Barclays' Strategy Update Should Strengthen Bank but Execution Will be Key

Fri May 9, 2014 8:33am EDT

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May 9 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings says that Barclays plc's (A/Stable/a) announcement that it plans to substantially reduce the size of its investment bank and concentrate on its core franchises should result in a more stable company profile. The bank announced that it plans to allocate no more than 30% of risk-weighted assets (RWA) to the investment bank. The strategy update follows the investment bank's weak performance in 1Q14, when the bank's fixed income, currencies and commodities (FICC) business underperformed many peers.

Fitch views execution of the strategy without damaging the 'core' parts of the investment bank that are being retained as being key. The announcement in itself has no impact on the bank's ratings. However, the bank's modestly higher fully-applied Basel III common equity Tier 1 (CET1) ratio target (at least 11%), the reduction in leverage that will ensue (revised target of at least 4% leverage ratio) and the more stable and higher earnings profile that should follow are positive developments. For this improvement to be realised, the bank will have to materially reduce the legacy and non-core assets transferred into a non-core unit to reduce earnings drag from these assets and reduce operating costs as planned.

Barclays announced on 8 May that it intends to concentrate on four core businesses, personal and corporate banking, credit cards, African banking and investment banking. As part of its strategy update, Barclays announced the creation of a non-core unit, which will hold about GBP115bn RWA (GBP400bn leverage exposure). These include GBP59bn RWA already defined as 'exit quadrant assets' under the bank's previous strategic plan. A large proportion (GBP90bn) will be transferred from the investment bank and will include non-standard fixed income derivatives, the bulk of the group's commodities business and emerging markets products. The non-core unit will also comprise the group's entire European retail business, which it plans to exit completely.

The bank's core investment bank will concentrate on its core franchises in the UK and US in equities and credit in both origination and trading. Macro trading businesses will be focused on shorter-term centrally-cleared and collateralised transactions and foreign exchange. As a result, the remaining investment bank will operate with about GBP120bn RWA by 2016, down from GBP222bn at end-2013. The material reduction in balance-sheet intensive rates businesses will also reduce leverage exposure by about 53% by 2016.

We believe that the bank's greater focus on shorter-term transactions in fixed income should reduce earnings volatility and lead to cost savings if transactions are processed on a small number of platforms. In 1Q14, the investment bank posted a 49% yoy drop in pre-tax profit to GBP668m, mainly as a result of a 41% decline in FICC trading revenue. This decline was sharper than at most peers, partly because the bank initiated its repositioning in macro businesses during the quarter. The drop also highlights the relative importance of macro businesses, which performed weakly in the quarter for all peers, including Barclays.

As part of its strategy update, Barclays announced that its UK retail and corporate banking business and its wealth management will be combined under one division. Putting the two divisions together should help the bank prepare for establishing a ring-fenced entity in the UK as required under domestic legislation, but details on the final regulations have not yet been announced.

Personal and corporate banking will operate with about GBP120bn RWA and should continue to benefit from its strong retail mortgage and corporate franchise in the UK. In 1Q14, the bank's retail and domestic corporate business performed well as the UK retail business reported GBP360m pre-tax profit, up 20% yoy, mainly on the back of lending growth and lower loan impairment charges. We expect Barclays' UK business to continue its healthy performance in an improved operating environment, and cost savings from the simplification of product offerings and increased direct channels should further help underpin performance.

Barclaycard continued to perform well in 1Q14 and reported a 17% increase in pre-tax profit to GBP423m helped by cost control, lending growth and modest loan impairment charges and the bank plans further growth in this business, where Barclays has strong franchises in several countries and sees scope for expanding activities further.

Barclays' Africa banking business, which operates with about GBP40bn RWA at end-2013, is expected to see further growth as the bank plans to concentrate in its main franchises in South Africa, Kenya, Ghana, Botswana and Zambia. In 1Q14, Africa retail and business banking generated GBP101m pre-tax profit, up 25% yoy.

The increase would have been higher at 75% excluding the effect of the sharp depreciation of the ZAR as lower loan impairment charges and a 13% decline in operating costs compensated for a 15% decline in reported net revenue caused by currency movements.

Assets in the new non-core unit will include a high proportion of former investment banking assets, which the bank intends to materially reduce together with the non-core assets from other divisions. During 2014, the bank plans to reduce RWA in the unit by about 30% to GBP80bn, with a further reduction to GBP50bn by 2016. The group's earnings will be affected by low income and operating expenses related to managing these assets, and the bank will have to demonstrate that it can hedge positions adequately to avoid material earnings volatility or losses in the unit, which the bank currently does not expect. A material asset reduction in the unit will help the bank achieve its capitalisation targets and should enable it to reduce operating expenses further.

Barclays increased its fully applied CRD IV CET1 target ratio to above 11% by 2016 (and above 10.5% by 2015) and its Basel III leverage ratio to above 4% (3.5% by 2015). The bank's fully applied CET1 ratio was 9.6% and its CRD IV leverage ratio was 3.3% at end 1Q14. Maintaining sound capitalisation is a key driver for Barclays' Viability Rating, and we expect the bank to achieve and maintain sound capitalisation in line with its peers. The reduction of RWA and leverage exposure in the investment bank should also help the bank meet increasingly stringent local regulatory capital requirements, particularly in the US, where Barclays will have to establish an intermediate holding company for its US subsidiaries by 2016.

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