Bob the Builder: Diamond’s legacy at Barclays

The abrupt end to Bob Diamond’s glittering career should not disguise his remarkable achievement in transforming Barclays into a premier league investment bank – but at what cost?

Whatever you think about Bob Diamond and the Libor scandal – and what many people think is not fit to republish here – it is important to acknowledge his achievement over the past 15 years in building a top tier investment bank off the shaky foundations of Barclays’ sterling bonds and money markets business way back in 1997.

At the time, many people thought he was mad. A profile of the bank in 1997 by Antony Currie, now a columnist at Breakingviews, concluded that the bank was either deluded or desperate in rejecting the wisdom of the day – that all investment banks needed to offer a full suite of debt, equity and advisory in order to flourish – and instead focusing purely on fixed income.

The question of course, is at what cost did this almost unique achievement – the only other bank to achieve it from scratch has been Deutsche Bank – come? Ultimately, was it worth it?

Going up…

As the charts below demonstrate, the growth at Barclays Capital (as it was until this year), was extraordinary, even in the context of the extraordinary boom in the banking industry over the past 15 years.

Let’s start with its balance sheet. In 1996, the year before Diamond became chief executive of Barclays Capital, Barclays had a balance sheet of £185bn, split roughly equally between its investment bank BZW and the rest of the group. Fast forward to last year, and that balance sheet had ballooned to £1.56 trillion, more than eight times larger, with the investment bank conusming three quarters of it. In other words, the balance sheet of the investment bank had grown 13-fold over the previous 15 years.

The picture ic complicated by the bank’s adoption of international accounting standards in 2005, which probably means the investment bank’s balance sheet is probably ‘only’ about £700-800bn, or around two thirds of the group’s balance sheet. The speed of growth is, however clear.

…and up, and up…

You get a similar picture with profits. The investment bank made pretax profits of just £207m in 1996 – which sounds almost quaint today – accounting for just 9% of Barclays’ overall profits of £1.85bn, according to its annual report for the year. Fast forward to 2011 and pretax profits at Barclays Capital had surged 14-fold to £2.97bn.

The surprising factor is that Barclays Capital was not as big a contributor to the group’s profits before the financial crisis as you might expect, generating between 20% to 30% of group profits. It is only since the crisis that it has really come to dominate the numbers.

When you strip own credit or DVA out of the group’s numbers (that it, the profit or loss booked on the value of the bank’s own debt), Barclays Capital was responsible for three quarters of the group’s pretax profits between 2009 and 2011.

Another way of looking at this growth is that in 1997, Barclays Capital had just 4,000 staff, wheras today its has some 24,000.

Last year, on my numbers, Barclays was the sixth largest investment bank globally in terms of revenues from its sales & trading and investment banking business, and the fourth largest in terms of profits and profitability (although like most banks, its return on equity was below its cost of capital). Boosted by its audacious acquisition of Lehman Brothers’ business in the US in 2008, it is the fourth largest player in fixed income, currencies and commodities, seventh in investment banking and ninth in equities.

On paper, this looks like an impressive achievement, particularly as Barclays’ other UK and European rivals (with the exception so far of Deutsche Bank) have all tripped up on their own over-ambition over the past decade in trying to build a top tier global investment bank.

Falling down…

But, given the shocking denouement over the past few weeks to the Diamond project, you have to ask at what cost was this achieved.

First, and most obvious, is that shareholders have not been rewarded in the same way as Diamond and his senior colleagues. Since the beginning of 1997, Barclays’ shares have fallen by nearly a third, and they have collapsed by nearly 80% from their highs in early 2007.

Second, responsibility for the poor performance of the shares can largely be placed at the door of the group’s increasing reliance on its investment bank. Much of the investment bank’s growth was fuelled by increased leverage. Raw leverage (that is, reported assets divided by allocated equity) peaked at around 80 times in 2008, although when you adjust for accounting standards its was probably ‘only’ about 45 times.

As the crisis unfolded from 2007 onwards, Barclays’ balance sheet was stretched too far, forcing it to raise capital twice to prevent the bank from slipping into the claws of the UK government. In 2009, it was forced to sell one of its prize businesses – Barclays Global Investors and with it the  iShares ETFs business – to boost its capital (note that Diamond pocketed a cool £16m from the sale).

While this generated much needed cash, it further exposed the group to the investment bank, putting even more pressure on its balance sheet, share price and earnings capacity. This means that Barclays is now more exposed than ever to a business whose ability to generate a return in excess of its cost of capital is more challenged than ever. In 1996, Barclays made a pretax return on assets of 1.25%. By last year, this had plunged to 0.3%.

Third, and perhaps less tangibly, the group has become dominated by senior executives from the investment bank and the culture they have brought with them. However much Diamond protests that he was unaware of the behaviour of a few bad apples until recently – which sounds more implausible the more he says it - the fact remains that he created and presided over a culture in which, at best, senior management chose not to ask themselves difficult questions, and at worst, more than a few bad apples thought it perfectly OK to engage in systemmatic illegality that went unchecked for years.

In many ways, Diamond and his team can be proud of what they have achieved against the odds. But in the final reckoning, with the outlook for Barclays and its investment bank uncertain, it is hard to say that this achievement is anything more than a Pyrrhic victory.