Barclays manages expectations and shares lower

Barclays is rightly taking the cautious path, despite one of the smoother sets of European banking results of 2016 in the sector’s reporting season.

A ramp in profitability of almost three times that of 2015’s annual adjusted pre-tax profit to £3.2bn that was still somewhat below an average forecast of £3.97bn, in our view points to external optimism running too far rather than a missed opportunity. The group is also six months ahead of schedule in its disposal programme for non-core businesses, including the sale of a first stake in Barclays Africa, with Egypt and French Retail businesses on the slate in 2017.

Momentum of profit improvement and of the “non-core rundown”, a surprise leap in the key regulatory capital buffer (Common Equity Tier 1 ratio) to 12.4% from 11.6% in September, a widely anticipated return to group profitability in the fourth quarter, and still best-in-class Return on Tangible Equity (RoTE) performance at the UK retail franchise (19.3%), were the key reasons for investors’ initial positive reaction on Thursday.

Even so, explanation is due for the share price jump fizzling out and reversing having initially surged well above 3%. We think shareholders are largely picking up on the mood of management, which appears to have decided that it’s time to moderate expectations. As well as the CEO flatly noting that his team was “not talking about increasing the dividend yet”, Jes Staley will have a clutch of snags and one or two more serious challenges on his screen to encourage him to keep the powder dry. The Dept. of Justice’s civil RMBS case, for one thing, still has the capacity to go against the group in way that is not materially factored into expectations. (Barclays is alone amongst a group of banks contesting a DoJ RMBS case).

At the same time, the pace of underlying returns recovery is slowing, as we have long expected it would. Surging RoTE reported by the markets-exposed Barclays International division of 14.3% at the half-year has dropped significantly to 8% year-on-year, excluding notable items. That represents a further fall after RoTE slid to 10.5% in Q3 2016. Even Barclays UK returns took a modest 20 basis point step backwards during the year. Getting out of Africa isn’t going quite to plan either. Having stated last March that it would sell its entire stake in Barclays Africa within 2-3 years, the group has done only one block to date, with 50% still on its books after two potential buyers withdrew.

In other words, Barclays had a strong year, though the details were not optimal in view of key risks. We’re minded that the group’s cost of capital (WACC) is in the balance whilst what Moody’s refers to as “material litigations” are also in the balance. A deceleration in the decline or even a small rise in WACC will certainly remove the chance of further positive surprises on CET1, which is still lagging Barclays’ less diverse rival Lloyds Banking Group (14.9%) and Switzerland’s UBS (14.2%). Barclays’ now unique position amongst UK-facing peers as a fully-fledged international investment bank is a strong counterbalance to our caution, as that division catches up with U.S. competitors in credit trading (+44%).

But whilst Barclay’s future is brighter, it is no less strewn with hazards.