Sherborne Investors Management LP Letter to Shareholders of Barclays PLC

Sherborne Investors Management LP Letter to Shareholders of Barclays PLC

PR Newswire

NEW YORK, April 8, 2019

NEW YORK, April 8, 2019 /PRNewswire/ --

Dear Fellow Shareholder,

We are writing to you to ask for your support of Resolution 24 that our firm, Sherborne Investors Management LP ("Sherborne Investors"), has requested to be voted on at the Annual General Meeting of Barclays PLC ("Barclays") to be held on May the 2nd. Our resolution proposes the election of one of our partners, Mr. Edward Bramson, to serve as a non-executive director.

Introduction

Barclays' current strategy to commit significantly more resources to its Corporate and Investment Bank ("CIB") was initiated around the time when Mr. John McFarlane, the current chairperson, was appointed in 2015. In its AGM notice the board asked that shareholders continue to endorse a "persistent and diligent execution of [this] strategy… to drive greater returns for shareholders". As shown below, after several years of trying, the board's strategy has still not produced any positive shareholder returns1:

 



Barclays


UK Peers2


CIB Peers3

Total Shareholder Return

(29.0%)


3.1%


73.7%

Price / Tangible Equity (% change)

(30.2%)


(4.9%)


15.5%

Price / Tangible Equity (current)

0.62x


1.09x


1.36x

 

A comparison with the peers shown above makes it clear that uncontrollable factors, such as Brexit, do not account for Barclays' underperformance. The cause is, we believe, the board's prolonged pursuit of a strategy that is not grounded in the fundamental realities of the global CIB marketplace.

The board has not offered any credible reason to believe that persisting in this strategy will produce better results for shareholders in the future than it has since its inception, as even the modest 2018 return on Group tangible equity of 8.5% was achieved only because of non-recurring items that, by our estimate, added more than £700 million to profit before tax for the year. We are also concerned that the CIB's long-term competitive position remains strategically weak, as explained below.

A thoughtful reassessment of the board's underlying strategic assumptions seems to be overdue. As part of such a reassessment, we hope to see greater emphasis on the issues outlined below.

Barclays Share Valuation

We believe that the market's evaluation of Barclays' shares reflects the growing risks that the CIB poses to Barclays' overall financial position and that the market does not share the board's optimism that the hidden merits of its strategy will eventually become apparent.

Continuation on the existing course represents a real threat that more new capital will need to be raised to underpin the activities of the CIB. We believe that any new capital invested in the CIB is 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, which we also believe is true of the capital invested in the CIB today.

In order to raise new funds, as it has many times in recent years, Barclays would most likely be forced to:

1)    Issue new shares at a punitive price for existing shareholders; or
2)    Sell further attractive businesses; or
3)    Reduce dividend payments.

If concerns about involuntary fund raising and misallocation of capital were to be resolved, we believe that Barclays' share price could begin to recover. A judicious rebalancing of the CIB strategy, especially in its Markets trading activities, could reduce the need for new external capital and result in a sustainable, competitive, global business at much lower risk and cost to the Group's shareholders.

Group Balance Sheet Risk

Barclays has evolved from a bank into a holding company with two main banking subsidiaries, Barclays Bank UK PLC and Barclays Bank PLC. Both of these subsidiaries are, as required by regulation, well capitalised as they benefit from the infusion of approximately £90 billion of loss absorbing capital provided from their parent, Barclays PLC, which is the legal entity that shareholders own directly. As a result of these regulatory capital injections, the subsidiary banks have strong credit ratings of A1 and A2, respectively, and pose no reasonable likelihood of loss to depositors or taxpayers. The risk of loss now rests squarely on Barclays' shareholders, which is clearly as it should be.

Barclays PLC itself, however, is in a weaker position than its subsidiaries, as it has only some £40 billion of its own eligible shareholders equity and is therefore borrowing the balance of the £90 billion that it has provided to its subsidiaries. The risk to shareholders from the resulting parent company gearing is magnified by the low returns of the CIB, which absorbs the majority of the Group's capital.

The board's recent AGM notice claims that the capital position of the Group is "strong". However, as shown below, this is not supportable. The Group's parent company senior unsecured credit rating is notably the weakest among global peers and represents an increasingly imminent risk to shareholders:

Bank


Moody's

Rating4

Bank of America


A2

HSBC


A2

JP Morgan


A2

Wells Fargo


A2

Citigroup


A3

Goldman Sachs


A3

Lloyds


A3

Morgan Stanley


A3

UBS


A3

Credit Suisse


Baa2

RBS


Baa2

Barclays


Baa3

 

Any further reduction would leave Barclays with a non-investment grade bond rating from Moody's, which would be unthinkable and would hinder Barclays' global competitiveness. The announcement of a potential downgrade at some point in the next market cycle is, we believe, a very likely catalyst for the need to raise new capital on the punitive terms to shareholders that we mentioned earlier in this letter.

The board has been unresponsive to our concerns, and those of other shareholders, about Barclays' leverage and credit rating. However, we believe strongly that it is prudent for the board to address this weakness now while market conditions are still relatively favourable.

Reality of CIB Market Position

Since 2015, Barclays' principal CIB strategy has been to constrain its Risk Weighted Asset ("RWA") growth by substituting "capital-light, shorter-dated, standardised and cleared" trading assets. This has enabled the addition of more than £300 billion of assets without a material addition to the equity capital of the CIB as would otherwise have been required. This exercise has increased the assets of the CIB by approximately 60% in an effort to generate incremental revenue and to use the additional trading activity to bring in other types of business. The strategy has failed to generate any additional revenue and it has also failed, predictably, to broaden the CIB's more strategically desirable corporate customer base.

We believe that the current strategy is untenable in the long run because it fails to take into account competitive realities in the CIB marketplace, which we explain below.

CIB Customer and Product Mix are Uncompetitive

CIB revenue yields correlate with the mix of products that a firm sells and this mix is strongly influenced by the type of customer to which it sells. Revenue yield does not necessarily equate to profitability, which is influenced by many factors, such as costs. However, it is a highly objective measure of comparison between companies in the same lines of business.

Shown below are generally accepted rankings of revenue yield for the major products in the CIB market. We also show the type of customer that is the principal buyer of each product to illustrate the strategic disadvantages of Barclays' customer mix:



Relative


Principal Purchasers



Revenue




Global


Product


Yield


Buy Side


Corporates


M&A


Highest Yield




x


Transaction Banking





x


Securities Services


|


x




ECM


|




x


Corporate Lending


|


x


x


DCM





x


Markets (FICC & Equities)


Lowest Yield


x



 

As shown, the higher-yielding CIB products are principally purchased by global corporate customers. Barclays' CIB assets are, however, concentrated in products purchased by "Buy Side" customers, such as hedge funds and private equity firms, which provide lower revenue yields.

Poor Customer Mix Depresses Markets Revenue Yield

Barclays and its CIB competitors typically have a significant portion of their portfolio dedicated to the Markets business line in the form of trading assets – in the case of Barclays it is approximately 90%. Accordingly, yields on trading assets are a major determinant of overall CIB yields. The yield on trading assets tends to correlate to the proportion of its trading activity that is generated by a firm's corporate customers or by customers of its wealth management business.

Barclays has a large balance sheet, but, by global standards, a small corporate banking market share and sold its asset management business some years ago. Looking at the familiar names in the table below, it is evident that the competitively viable firms are those with extensive corporate banking or wealth management businesses, or in some cases both, as these result in a higher quality mix of customer driven trading in their Markets businesses5:







CIB







CIB


CIB


Revenue


CIB


CIB


($ billions)

Revenue6


Assets7


Yield8


Leverage9


RoTE10

Universal:











Citigroup

37.0


1,749


2.1%


21x


14.3%


JP Morgan

36.4


1,416


2.6%


20x


16.0%


Bank of America

35.7


1,398


2.6%


18x


16.0%












U.K. Overseas:











HSBC

30.4


1,408


2.2%


15x


12.1%












Specialist:











Goldman Sachs

21.3


1,103


1.9%


18x


14.1%


Morgan Stanley

20.6


936


2.2%


23x


11.0%












Trading:











Deutsche Bank

15.4


1,292


1.2%


25x


0.9%


Barclays

13.0


1,100


1.2%


32x


7.1%

 

A position in the top ten might seem encouraging, but in practical terms Barclays' CIB revenue is only one-third that of the market leaders, its revenue yield is only half of the level required to be a viable competitor, and its leverage has reached the practical maximum. The CIB's uncompetitive return on capital has persisted even though Barclays has committed more than £300 billion of additional trading assets and increased leverage to conspicuously high levels to support it.

Since it is extremely difficult and time consuming to gain corporate customer market share, Barclays' CIB has instead aggressively pursued "Buy Side" business which can be gained more quickly and easily through price reductions or loosening of credit standards. After several years of experimentation with the low RWA density, high leverage strategy described above, the results confirm that 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:


(£ billions)

2015


2016


2017


2018


% change

CIB Revenue

£    10.5


£    10.5


£      9.9


£      9.8


(7%)

CIB Average Assets11

£     503


£     524


£     682


£     789


57%)


CIB Revenue Yield

2.1%


2.0%


1.4%


1.2%


(40%)

 

We believe it is clear that a modern CIB cannot be competitive without a successful Markets presence. For those of Barclays' competitors that have significant complementary businesses in corporate banking or wealth management, Markets is a highly positive contributor to overall CIB returns. The Markets businesses of firms like Barclays that do not have strengths in these complementary areas are at a structural disadvantage which, as Barclays' results have demonstrated, cannot be overcome simply by adding ever more trading assets with leverage. We think the board should take the time to develop a more thoughtful strategy for this important line of business.

It should be a cautionary sign to the board that Barclays and Deutsche Bank have similar strategic weaknesses and have pursued similar product and customer strategies, resulting in revenue yields that are identical.

Again, we believe that the board should take the opportunity to reconsider its strategy now and to strengthen Barclays' financial position, while market conditions are still relatively favourable.

Board "Selection Process" Inhibits Diversity of Perspective

The board's exclusive control of its "usual rigorous formal selection process" has not resulted in positive governance outcomes for Barclays over a very long period of time. The "process" has severely reduced the diversity of perspectives represented in board discussions and we believe that the addition of one director proposed by shareholders would have a healthy effect on the board's insularity which handicaps it at present.

Our nominee's perspective would be merely one on a board assumed to number twelve or more, but a review of the information provided for the current directors indicates that he clearly would add to the balance and diversity of skills and experience in matters relevant to many of the board's more pressing issues.

Mr. Bramson has extensive experience in the areas of capital markets, credit, and mergers and acquisitions. He could contribute significant insight into the attitudes of investors gained from experience as a portfolio manager at Sherborne Investors and as the former chief executive of a large, publicly quoted asset manager in the United Kingdom. He has also performed various regulated management functions and is familiar with the responsibilities of regulated businesses.

Stabilising Board Influence and Complementary Experience 

As chairman or chief executive of several quoted commercial, industrial, and financial companies in the United Kingdom and the United States, Mr. Bramson has, as the board's AGM notice highlights, substantial familiarity with public companies in the course of organisational change. In view of Barclays' most recent announcements of sudden management realignments and departures, we believe that Mr. Bramson's experience and temperament would be a strongly stabilising influence on the board.

The significant gains in operating performance and shareholder value that Sherborne Investors has brought since 2003 to the public companies in which it has invested are the result of an orderly and consistent approach to issues and of an inclusive attitude to management and employee insights and concerns. We believe that this background would add to the board's experience and skills. The experience of the incoming chairperson, Mr. Nigel Higgins, appears to be limited to advisory or mergers and acquisitions work in a firm that is family-controlled and our candidate would be able, if and when requested, to offer support and advice in dealing with the capital, organisational, and other issues that the new chairperson will have to confront.

We agree with the board's statement that "a seat on the board is not needed for a shareholder's views to be considered by the board." Rather, a person's credentials and experience to serve shareholders as a whole are what should count. The board's assertion that it "does not believe that Mr. Bramson's appointment would add to its skills, experience, diversity or effectiveness" is contradicted by a review of the directors' backgrounds included in Barclays' annual report. A "process" that excludes director candidates simply because they are nominated by shareholders, rather than by the incumbent directors, encourages an insular perspective and seems to serve no useful purpose. It is noteworthy that few, if any, of the existing directors meet the standards of experience that the board seeks to apply to Mr. Bramson, which reinforces the impression that the process is, in fact, simply discriminatory.

Summary

The success of Barclays is critically dependent on depositors, customers, and employees, but shareholders have legitimate interests too.

Investors might be expected to accept higher financial risk in the near-term if it seemed likely that long-term returns would compensate them for doing so. Based on the current CIB strategy, this seems implausible to us and to other investors.

If, after such a long period of disappointing performance on many levels, you would like to make it known to the board your wish for new perspectives on what is in the best interest of Barclays and its shareholders, we respectfully ask you to vote IN FAVOUR OF Resolution 24.

Yours faithfully,

Sherborne Investors

1       From 22 April 2015 to 5 April 2019 or as at 5 April 2019, as appropriate
2    Average of HSBC, Lloyds, and RBS
3    Average of Bank of America, Citigroup, Goldman Sachs, JP Morgan, and Morgan Stanley
4    As at 5 April 2019; represents most senior unsecured debt class in group's top entity; excludes BNP Paribas (Aa3), Societe Generale (A1), and Deutsche Bank (A3) which are not holding company issuers; UBS represents parent-guaranteed funding entity, UBS Group Funding (Switzerland) AG
5    Bank of America CIB represents the aggregate of Global Banking and Global Markets; Citigroup CIB represents Institutional Clients Group; Deutsche Bank represents Corporate & Investment Bank; Goldman Sachs CIB represents the aggregate of Investment Banking and Institutional Client Services; HSBC represents aggregate of Commercial Banking and Global Banking and Markets; JP Morgan CIB represents Corporate & Investment Bank; Morgan Stanley CIB represents Institutional Securities
6    Barclays reported revenue of £9.8 billion converted at $1.33/£ 2018 average FX rate; Source:  Barclays 2018 Results Announcement
7    Average 2018 assets, adjusted to exclude netting credits related to derivatives assets for comparability ("Gross Assets")
8    Represents 2018 revenue divided by average 2018 Gross Assets
9    Represents 2018 average Gross Assets divided by 2018 average allocated equity; Goldman Sachs reflects group leverage ratio
10   Represents 2018 CIB return on allocated equity ("RoTE"); Goldman Sachs represents group RoTE
11   Represents average total assets of Barclays International, less Consumer, Cards & Payments loans and advances and estimated International Wealth assets

 

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