Shares in Barclays (LSE: BARC) have fallen 5% this week. And deservedly so: if you announce soaring bonuses for investment bankers while profits are falling, there's always going to be trouble.
Some investors think the drop in price has left Barclays looking good value, and that this is a buying opportunity.
But I'm not one of them.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
The bonus situation is bad enough it shows an unhealthy lack of respect for shareholders but at a more fundamental level, Barclays faces serious challenges on both sides of its business. They'll be expensive and difficult to deal with and I'm not prepared to gamble on the Barclays team being able to pull it off.
Why shareholders should be worried about big bonuses
But in fact, this is something that shareholders should be annoyed about, because Barclays paid out three times more bonus money to staff than it paid dividend money to shareholders.
The picture is even worse at the investment banking division (that's where the City and Wall Street bankers are based). Bonuses for investment bankers jumped 13% to £1.58bn last year, even although profits in this division fell 37% to £2.5bn.
Barclays argues that it can't retain the best bankers unless it pays high bonuses. But if that's true, then I fear that costs at the investment banking division will always be too high for shareholders to ever get a decent return on their investment. I'm not interested in owning shares in a company that ends up being run purely for the benefit of its staff, rather than its shareholders.
I also fear that the bank's relatively new chief executive, Anthony Jenkins, is failing in his attempt to change the culture at Barclays that's the message I get from soaring bonuses.
Investment banking is a terrible business
But I disagree. You see, mergers and acquisitions (M&A) have traditionally made up a big part of investment banking revenues. But the M&A market is changing.
As John Authers pointed out in the FT on Monday, the number of mergers will probably never return to the heights we saw in the late 90s. Many industries are now dominated by a few large players, and competition authorities won't permit further takeovers.
Things don't look much more promising at Barclays' FICC division (fixed income, currencies and commodities). This is now the heart of Barclays' investment banking business.
Profit margins are under pressure. Returns have been hit by regulators' insistence that investment banks carry more capital on their balance sheets.
If you're not up to speed on returns on capital, think of it this way: if a bank has capital of £1bn and makes £100m in profit, the bank is generating a 10% return on capital employed.
But if regulators insist that the bank has £3bn of capital on its balance sheet, the return falls to 3.33%. (For more on returns on equity watch my video on the topic.)
Accountancy group McKinsey reckons that the average return on equity in investment banking currently is 8%, and could fall to 4% by 2019 if nothing changes. 8% is too low and 4% would be very poor.
High street banking doesn't look much healthier
The good news is that Barclays has a decent UK customer base. But the high street banking business faces plenty of challenges: fresh scandals emerge on a regular basis, and more cost cutting is needed. That means shutting more bank branches, which is never popular with customers.
UK banking is also becoming more competitive. British banking has grown used to having very high barriers to entry, so the big four' banks have benefited from a semi-monopoly.
But we now have five main banks, plus challenger' banks such as Tesco and Virgin Money. And most importantly, TSB will almost certainly become a completely independent business later this year. This added competition will keep a lid on margins.
On top of that, politicians will likely continue to criticise banks and maybe even introduce further levies and fines. This is especially likely if Labour wins the next election.
What to buy instead
But it's not cheap enough for me. Costs are too high and I'm not confident that Jenkins can push through the culture change needed to address that. And I'm not keen on banks at the best of times, because it's so easy for them to hide unexploded bombs in their complicated balance sheets.
If you really feel the need to buy a UK bank, I'd opt for Lloyds (LSE: LLOY) on the basis that it has a nice UK high street business, unencumbered by overseas operations or an investment bank. I'd also consider TSB when it floats for the same reason.
But to be honest, I'd rather avoid the sector altogether. I recently wrote about some of the great opportunities on the Aim market. I also like the look of Japan and emerging markets. All three options carry their own risks but I reckon that the risk/reward ratio is much more in my favour in all three areas.
Our recommended articles for today
Rampant SuperGroup is outgrowing Britain
American stocks are expensive buy Russian ones instead
-
Protect what matters with bespoke insuranceYour life is unique, so is standard home insurance really designed to meet your needs? NFU Mutual’s Bespoke Home Insurance is designed to be tailored to your unique circumstances.
-
The 30 house price hotspots
While we have seen house prices sliding, these sought-after locations have seen prices jump by at least 5% over the previous 12 months
-
Banks pass stress test
Features Britain’s seven biggest lenders have passed the second round of annual stress tests – but how resilient are the tests?
-
Barclays gives its boss the boot
Features Barclays has fired its CEO Antony Jenkins after three years on the job. He will be replaced by the chairman, John McFarlane, on an interim basis.
-
Barclays shrinks investment bank
News Barclays is still struggling with their investment banking arms following another round of disappointing results.
-
New technology is threatening the big banks, but there's one that's still worth buying
Features Mobile and online banking are making traditional bank branches obsolete. But one bank in particular is still a buy, says Matthew Partridge.
-
BNP and Barclays misbehave
News Regulators in America have levied heavy fines on the banks for breaching its rules.
-
Don’t be tempted to buy banks – here are two better options
Features Bank shares might look cheap right now, but don't be tempted. There are better places to put your money, says Ed Bowsher. Here, he picks two stocks to consider instead.
-
Barclays: bonuses up, profits down
News Despite falling profits at Barclays, the bank has seen fit to raise employee bonuses.
