When I'd Buy Barclays

Barclays (NYS: BCS) , Britain's third-largest bank by market value, released its first-quarter results this morning.

Although these showed strong improvements in many areas (notably investment banking), the bank let down some optimistic investors by not raising its puny dividend.

More PPI problems
In the first three months of this year, Barclays made an adjusted, before-tax profit of close to 2.5 billion pounds, up 22% on the first quarter of 2011.

This profit was driven by a 5% improvement in total income (net of insurance claims) of 8.1 billion pounds, plus a 16% reduction in bad-debt charges to 778 million pounds. Barclays' operating expenses rose by just 2% to nearly 5 billion pounds, but its cost/income ratio nevertheless improved to 61% from 62%.

As a result, basic earnings per share leapt by 27% to 13.6 pence from 10.7 pence. Even so -- and somewhat disappointingly -- Barclays held its interim dividend at 1 pence.

Now for the bad news: These are adjusted results, which do not take account of two huge accounting writedowns Barclays booked in the first quarter.

First, there was a loss exceeding 2.6 billion pounds because Barclays' creditworthiness improved, increasing the price of its own bonds and thus pushing up this liability. In the first nine months of 2011, Barclays' results were flattered by a 3 billion pound gain in the value of its own debt, which has now largely been reversed.

Second, the bank put aside another 300 million pounds to meet the cost of mis-sold payment protection insurance policies. This comes on top of 1 billion pounds already set aside to pay compensation to swindled borrowers.

Taking these two provisions into account, Barclays made a statutory loss of 475 million pounds before tax, versus a before-tax profit of nearly 1.7 billion pounds a year earlier. Overall, this equates to negative EPS of 4.5 pence.

Boosting Barclays
Other key performance indicators suggest that Barclays' health continues to improve, despite the UK's weak economy. The bank made a return on equity of 12.2%, two full percentage points ahead of the 10.2% it made in Q1 2011. Also, its loan-loss rate fell to 0.63% from 0.76% a year earlier.

Atypical among the big banks, Barclays' balance sheet actually grew in the first quarter of this year, with risk-weighted assets creeping up by 3 billion pounds to 394 billion pounds. However, its "Core Tier 1" capital -- a measure of balance-sheet strength -- dipped to 10.9% from 11% at the end of 2011.

In common with all mega-banks, Barclays lowered its leverage in the aftermath of the 2007 to 2009 global financial crash. However, this ratio now stands at 21 times, against 20 times in December, up 5%. Nevertheless, Barclays continues to improve its liquidity: Its pool of liquid assets now holds 173 billion pounds, up 14% in three months.

As part of its risk-shedding, Barclays is also bringing down its loan/deposit ratio, which now stands at 116%, versus 118% at the end of last year.

As an asset play, Barclays may be attractive to some investors, thanks to a net asset value of 445 pence a share and tangible NAV of 381 pence -- both much higher than its current share price.

A more boring bank
Bob Diamond, the highly paid American chief executive of Barclays, said of these results: "The environment in which we operate remains unpredictable, but we have a proven ability to adapt and grow our businesses in the face of external change. Our strong mix of businesses, emphasis on serving customers and clients, and our focus on execution give me confidence in delivering on our return targets for shareholders."

While "Diamond Bob" is likely to get lots of stick from shareholders at this week's annual general meeting over his 27 million pound pay package, he is building a stronger bank.

As I write, Barclays shares trade up 2 pence at 213 pence, valuing the bank at nearly 26 billion pounds. At this price, Barclays trades on a lowly forward price-to-earnings ratio of 7.2 and offers a prospective dividend yield of 3.3%, covered a healthy 4.2 times.

Since I tipped Barclays at 139 pence last September, its shares have since risen by more than half, up a tidy 53%. Although I suspect there are more gains to come, I remain very nervous about buying financial stocks, not least because of the high probability of another eurozone meltdown.

Hence, before I'd be a repeat buyer of Barclays, I'd like to see one or more of the following happen:

  • A substantial increase in the bank's yearly dividend

  • Further deleveraging, taking Barclays' leverage into the teens from its current ratio of 21

  • A sustained price fall, thus pushing the bank deeper into value territory

In other words, I'd aim to see a cheaper, less leveraged, more dividend-friendly Barclays before parking my cash in the bank's shares!

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