Barclays warns on target as profits fall

Barclays (BARC) has warned that it may not be able to deliver its target of a 13% return on equity by 2013.

"Since setting the target the worse-than-predicted macroeconomic conditions, in addition to new regulatory constraints mean that we may not be able to deliver 13% returns by 2013," said chief executive Bob Diamond.

The warning came after the bank's worst quarter for three years as return on equity from the investment banking arm, Barclays Capital (BarCap) fell to 5.8% for the year, down from 7.2% in 2010 and less than half its target.

"We are not satisfied with the return on equity we delivered in 2011 and are committed to delivering steady improvement moving forwards," Diamond stressed.

On the whole, pre-tax profits for the group slipped 3% to £5.9 billion for 2011, despite posting "resilient" revenues, which climbed 3% year-on-year to £32.3 billion.

Adjusted income for the year declined 8% to £28.5 billion, driven by a 19% quarter-on-quarter decrease in fourth-quarter income at the investment banking arm, Barclays Capital (BarCap). Income increased in most other businesses despite continued low interest rates and difficult macroeconomic conditions.

"For 2011 we reported a slight decrease in profits, as reduction in income at corporate and investment banking was partly offset by income improvements in all other businesses, a significant improvement in credit impairment and cost reductions," highlighted Diamond.

Credit quality continued to improve, with impairment charges and other credit provisions down 33%, resulting in a loan loss rate of 77bps. However, broker Killik & Co pointed out that exposure to Portugal, Ireland, Italy, Greece and Spain (PIIGS) remained an issue, with £7.1 billion exposure to sovereign debt.

The cost saving target was also doubled. "Efficiencies across the business" meant that the bank now expected to make £2 billion of cost savings in 2013 from its initial target of £1 billion.

Finally, the bank's core tier 1 ratio strengthened to 11.0% from 10.8% in 2010.

Bonus pool

Total incentive awards declined 26% across the group in 2011, with BarCap's total incentive awards down 35% compared with 2010.

This implied that the total bonus pot for the year will now be about £2.15 billion, while it will be £1.5 billion at the investment banking division. Cash bonuses will be capped at £65,000.

However, there was no mention of Diamond's bonus. According to the BBC's Robert Peston, his maximum bonus for 2011 would be 250% of £1.35 million, or £3.4 million.

Outlook

Diamond stated that the economic and regulatory environment would continue to be "challenging" in 2012, highlighting lower levels of client activity and confidence, a low interest rate environment for the forseeable future and regulatory headwinds.

However, he was keen to reassure investors that Barclays was improving its competitive position across its businesses and said that the second half of 2011 was "as tough as it gets".

Finance director Chris Lucas was more optimistic. "The performance in January of Africa retail and business banking and corporate banking was consistent with the good performance achieved in 2011," he said, adding that improvements in market conditions resulted in an encouraging start to the year for BarCap. However, he warned that it was too soon to suggest a trend.

Analyst comment

Broker Killik & Co estimated that Barclays is currently trading on a 2012 price to earnings ratio of about eight times and at a 40% discount to tangible net asset value.

"Whilst there is still some concern over the level of exposure to the peripheral European countries, the underlying business performance is improving and the current valuation looks attractive," it said.

However, the broker recommended Lloyds Banking Group (LLOY) for investors looking for domestic UK banking exposure. And for investors looking for global banking exposure, Killik said that it preferred HSBC (HSBA).

Nic Clarke, analyst at Charles Stanley, echoed the view that Barclays looked cheap, adding that group pre-tax profits only down 2% was "impressive".

"However, even taking account of the tough environment for Barclays Capital, that the group return on equity fell back from 7.2% in 2010 to 5.8% in 2011 does highlight how far Barclays is from its strategic target of achieving a 13% return on equity by 2013," he commented.

"With its chief executive pointing out that significant 'event risk' exists (the euro situation) and given the difficult regulatory environment we remain wary about raising our recommendation on the stock despite the group's commendable performance in 2011," he added.

He rated the stock a 'hold'.

Barclays was the top performer on the FTSE 100 (UKX) during Friday morning, with its shares climbing up 4%.

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