Barclays: Big, But Too Small

It shines in investment banking and ETFs -- but to be a global star, it needs a megadeal

Dressed in a soft-shouldered, earth-toned suit, Lee Kranefuss looks every inch the San Francisco executive that he is. But on a recent summer day, Kranefuss, who has led Barclays Global Investors to a dominant position in the ballooning business for exchange-traded funds (ETFs) in the U.S., was on a visit to Barclays' London headquarters. His assignment: to plot a repeat of his American success in Europe. "It's time to put our efforts into Europe and grow it," he says.

BGI's exchange-traded funds, sold under the brand iShares, have made London-based Barclays PLC (BCS ) the proud parent of one of the world's hottest financial properties. Just four years ago, BGI plunged into the funds in a big way -- and it could not have chosen a better moment. Investors have flocked to ETFs, which cost as little as 0.20% a year in fees and all but eliminate taxable gains. The iShares family of funds, which number 121 globally, have grown fivefold since 2001, to $87 billion under management.

iShares isn't the only home run for Barclays, the British bank whose origins go back to a 17th century partnership of Quaker families. BGI is also putting its corps of math and science PhDs to work managing hedge funds and other vehicles that earn much fatter fees than index trackers like ETFs. Barclays also boasts an up-and-coming investment bank, Barclays Capital, that is making waves in the debt and derivatives business. While more than half of Barclays revenues still come from its bread-and-butter retail-banking business in Britain, that's just a springboard for the growth of its more enterprising projects.


A few years ago, Barclays wasn't a leader in much of anything except boardroom infighting. That was before Matthew W. Barrett blew in from Canada in 1999, becoming the bank's fourth CEO in less than a year. The longtime chief of the Bank of Montreal (BMO )says he found a "demoralized" organization that had lost sight of its own strengths. Since then, the Irish-born Barrett's new team of execs has produced solid financial results, doubling pretax profits from 1998-2003 to $7 billion on revenues of $22.6 billion. Total assets at yearend 2003 were $800 billion. Merrill Lynch & Co. (MER ) forecasts profit before tax of almost $4 billion for the first half of 2004 -- a 10.7% increase over the year-earlier period.

Barrett's most important contribution has been his role as a cool-headed problem solver for a bank he found on the verge of a nervous breakdown. "Matt breathed self-confidence back into the organization," says Deputy Group CEO John Varley, 48, who will succeed Barrett as CEO on Sept. 1. Barrett, 59, will stay on as chairman. Associates say Barclays won't change much under Varley, although he may be more cautious about big strategic moves.

The big question for Barclays managers and investors now is whether the handful of hot areas Barrett has favored can grow fast enough to secure the bank's place in a fast-changing financial world. At $54 billion, Barclays is the third-largest bank in Europe in market capitalization, although it may lose that spot if Santander Central Hispano (STD )'s proposed acquisition of Britain's Abbey National PLC (ANB ) goes through. Barclays doesn't feel threatened, but the deal does underline the trend toward bigger banks. Indeed, Barclays is dwarfed in its own market by HSBC Holdings (HBC ) and Royal Bank of Scotland Group. Barclays "is neither a small regional bank nor a large global institution," says John Paul Crutchley, banking analyst at Merrill Lynch in London. "The question is: What is next?"

Both Barrett and Varley insist that more investment in the hot growth areas can be the answer. Barclays is pumping an estimated $900 million -- a 20% increase over last year -- into investment banking arm Barclays Capital, into BGI, and into Barclaycard, the credit-card business that has proved a big moneymaker under Barrett, earning $1.3 billion last year -- a 16% increase over 2003.

The most remarkable turnaround has been in investment banking, a field the bank virtually abandoned in the late 1990s as too risky. Barclays Capital CEO Robert E. Diamond Jr., a former Morgan Stanley head bond trader, has refashioned what was left of the investment banking unit into a major debt-market player. Operating profit zoomed from $450 million in 1997 to $1.4 billion in 2003.

A determined, almost messianic salesman from Concord, Mass., Diamond has a clear strategy: Stay away from M&A and equities, where Barclays can't compete, and instead use Barclays' fat balance sheet to win debt deals. Barclays Capital takes big short-term risks on corporate loans and then quickly repackages them into bonds and derivatives. These are then distributed to Barclays' established network of hedge funds and other big-fish investors.

One happy client is Italy's Edizione Holding, the holding company of the Benetton family. In early 2003, Edizione went in search of 10 billion euros ($12.1 billion) it needed to acquire Autostrade, the Italian toll-road operator. The Benettons were turned down by 15 major banks before they found Barclays. The British bank came up with a 1.5 billion euro ($1.8 billion) loan that encouraged other banks to take a risk. Barclays' reward: a key role in a sophisticated $7.8 billion bond issue, the largest in Europe this year.

Some analysts worry, though, that Diamond's reach exceeds his grasp. He has increased Barclays Capital staff from 5,800 in December, 2003, to 6,900 today -- at a time of rising interest rates, when companies are curtailing bond offerings. But John Winter, head of European investment banking & debt capital markets, says that so much of Barclays Capital's business is corporate risk management -- as opposed to simple bond issuance -- that higher rates are "not a big concern."

Diamond has had such a Midas touch at Barclays Capital that Barrett also put him in overall charge of BGI, which manages $1.1 trillion in assets in more than 2,300 mostly institutional index funds, including the ETFs. Earnings were up 82% last year, to $330 million. In July, Barclays launched nine new ETFs based on indexes developed by mutual-fund researcher Morningstar. The bank is eager to expand the business even more, especially in Europe. Andrew Skirton, BGI'S global co-CEO, says that Barclays management would "encourage an acquisition that made sense." Possibilities include the ETF units of Société Générale or Credit Suisse Group. What's more, Diamond is leaning on BGI to parlay its low-margin index business into higher-fee areas such as hedge funds.

While pleased with his success, the avuncular Barrett concedes the job isn't finished. Relaxing with his feet up on a table, a red-and-gold box of Dunhill cigarettes at hand, Barrett gives most of Barclays' businesses a 6 on a scale of 10. British banking, which still accounts for about 55% of Barclays' profits, is a potential trouble spot. Rising British interest rates could chill consumer lending and credit-card borrowing, key Barclays businesses. And an October survey by Which?, the publication of Britain's Consumers' Assn., rated Barclays bank among the worst in Britain in terms of customer service. Barclays British business banking chief Roger Davis says he is adding staff and rejiggering compensation to encourage better service.

One frustration for Barrett as he moves up to chairman and closer to retirement is that he hasn't been able to find the merger or takeover that would make Barclays part of a global banking power. So far, Barrett has contented himself with small moves. He bought Woolwich PLC (BCS ), a British mortgage specialist, for $9.9 billion, and Spanish lender Banco Zaragozano in 2003 for $1.4 billion, making Barclays the sixth-largest bank in Spain.

Barclays did talk seriously to Bank of America Corp. (BAC ) before the Charlotte (N.C.)-based institution decided to snap up Boston's FleetBoston Financial Corp. (BAC ), according to a source close to the discussions. But Barrett isn't closing the door to any deal -- with Barclays either as the hunter or the prey. He warns that unless they consolidate, European banks will see American giants seize control of commercial banking in Europe, as they have largely taken over European investment banking. "The Europeans will hear footsteps," he says. Will they also hear the approach of Barclays bankers as they seek a deal? The story of this 300-year-old bank is far from over.

By Stanley Reed in London

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