Barclays Betting on Investment Bank Profit to Quell Pay Revolt

Barclays Plc (BARC) Chief Executive Officer Robert Diamond is betting that rising profitability at the investment bank he built will allow him to fend off a shareholders’ revolt over his compensation.

The U.K.’s second-largest bank by assets may say tomorrow first-quarter net income rose 18 percent to 1.19 billion pounds ($1.9 billion) from the year-earlier period, according to the median estimate of six analysts surveyed by Bloomberg. Investors will vote on Diamond’s 12 million-pound compensation at the company’s annual general meeting in London the following day.

Diamond, 60, offered to forgo 11 percent of his total compensation for 2011 if the bank doesn’t hit its profitability targets after investors including Standard Life Plc (SL/) criticized his pay. That leaves Diamond dependent on the investment bank, which last year generated about half of Barclays’s pretax profit. Europe’s sovereign debt crisis and Diamond’s ability to rein in expenses will be the keys to improving profitability, investors and analysts say.

“As a shareholder I’m much more concerned about whether they’ve made the right decisions about expanding aggressively into investment banking and how that will pan out,” said Julian Chillingworth, who helps manage 16 billion pounds at London’s Rathbone Brothers Plc. (RAT), including Barclays shares. “In five years that is what will have driven their stock up or down.”

Debt Crisis

Diamond, the U.K.’s best-paid bank CEO, expanded the investment banking unit by acquiring the North American unit of Lehman Brothers Holdings Inc. amid the 2008 financial crisis, and adding 2,000 bankers in Europe and Asia. Last year, the unit posted pretax profit of 2.97 billion pounds, or about 50 percent of the pretax income for the entire bank.

Barclays’s performance will be “contingent on how capital markets fare, especially relating to the sovereign debt crisis,” said Andrew Lim, an analyst at Espirito Santo Investment Bank in London, who has a buy rating on the bank. Bringing down costs “is a major part of the plan, and then they’ll be concentrating on taking market share in businesses such as currencies, commodities and fixed-income trading.”

Even as the investment banking unit’s 10.4 percent return on equity is beating the firm’s average, it will have to rise if the London-based bank is to reach its 13 percent target next year, analysts say. Barclays’s return on equity was an “unacceptable” 6.6 percent last year, Diamond said on Feb. 10.

Barclays’s Shares Rise

Barclays shares are up 20 percent this year, while the Bloomberg Europe Banks and Financial Services Index has risen 2 percent. Barclays closed yesterday in London at 211 pence, valuing the lender at 25.8 billion pounds.

“Barclays can’t meet their return on equity target until Barclays Capital does,” said Chirantan Barua, an analyst at Sanford Bernstein Research in London with an outperform rating on Barclays and a 360 pence target price. “Barclays Capital can’t make the target with a 45 percent compensation-to-net- income ratio. The expense ratio needs to be brought down. Pay people less or take out capacity. I think BarCap has 15 percent excess capacity.”

Diamond will probably keep his 24,000 investment banking employees in anticipation of business improving and try to take market share from competitors while lowering banker pay, Barua said. “We’ve hardly seen any wage inflation in investment banking so it shouldn’t be a very hard task,” he said.

Diamond’s Pay

Barclays’s board last week tried to quell shareholder dissent by tying Diamond’s pay to his ability to improve profit. Diamond and Finance Director Chris Lucas, 51, will lose 50 percent of their deferred bonuses for 2011 if return on equity doesn’t exceed the cost of equity within three years, the lender said. Diamond received a 2.7 million-pound bonus in stock and Lucas 1.8 million pounds. Barclays’s cost of equity was 11.5 percent, according to the 2011 annual report

Barclays is ranked fourth in mergers and acquisitions deals this year, with 21 percent of the advisory market, according to data compiled by Bloomberg. A Barclays spokesman declined to comment.

“In the first quarter, I’m expecting Barclays investment bank revenue to be better than market expectations,” said Ian Gordon, an Investec Bank Plc analyst who rates the bank a buy. “I’m expecting that to drive overall profits ahead of expectations.”

Citigroup Inc. (C) analyst Andrew Coombs estimated in a note to investors yesterday that investment banking operating profit rose 19 percent to 1.59 billion pounds in the first quarter from a year earlier.

‘Best in Class’

“We believe BarCap will emerge as the ‘best-in-class’ European investment banking franchise over time, taking the mantle currently held by Deutsche Bank,” Lim said a note to investors on April 23. The investment banking unit was the most profitable in Europe in the second half by return on risk- weighted assets, he said.

Standard Life’s Guy Jubb, global head of governance and stewardship, said the company would vote to support the bank’s pay report, saying “our key concerns over last year’s executive bonuses have been addressed.”

Barclays’s deferred share bonuses for 2011 are paid in three equal parts in 2013, 2014 and 2015. The announcement won’t affect Diamond’s 2.25 million-pound long-term incentive bonus, the bank said. In all, he got as much as 6.3 million pounds in salary, bonuses and stock awards for 2011 as well as a 5.75 million-pound contribution toward his personal tax bill.

“We’re happy enough with the concessions that have been made,” said Colin McLean, CEO of SVM Asset Management in Edinburgh, which holds Barclays shares. “Shareholders are happy with the leadership, but with the company not yet earning the return on equity it targeted the package looked excessive.”

PIRC Objects

The concession, agreed a week before shareholders meet to decide upon the pay report among other resolutions, didn’t placate Pensions Investment Research Consultants Ltd., which this month urged investors to vote down Diamond’s pay and reiterated its advice last week.

“The announcement does not address the fundamental issue of rewards for failure,” PIRC, a London-based corporate governance adviser, said in a statement. “The proposed change acknowledges a problem with the bonus scheme, but still keeps it in place.”

The Association of British Insurers, whose members own 15 percent to 20 percent of all Britain’s publicly traded companies, said Barclays’s pay plans should be scrutinized before shareholders vote on the compensation.

Citigroup investors last week rejected the New York-based bank’s executive pay plan amid criticism it lets CEO Vikram Pandit collect millions of dollars in rewards too easily.

UBS AG (UBSN) will base CEO Sergio Ermotti’s bonus in part on the progress he makes in restoring the reputation of Switzerland’s biggest bank, Chairman Kaspar Villiger said on April 18.

“We’ll have this argument endlessly” on executive banker compensation, Rathbone’s Chillingworth said. “There’s going to be lots of discussions about how they get paid.”

To contact the reporter on this story: Howard Mustoe in London at hmustoe@bloomberg.net

To contact the editor responsible for this story: Edward Evans at eevans3@bloomberg.net

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