The Business Of

Banking | Barclays | What Do They Do With Their Profits?

Morning All!

Yesterday we put together Barclays’ costs with their revenues. And we’ve covered a fair amount this week. So, let’s have a quick recap…

• The Interest Difference: In 2022, Barclays PAID an average interest rate of 0.7% on deposits. Crucially, they RECEIVED an average rate of 3.4% on loans.

• The Salary Difference: Barclays’ staff costs/employee ratio of £106k was miles below Goldman’s $312k. The main reason being the lower paid support staff!

• EBT Margin: We saw that whilst Barclays EBT margin was healthy in 2022 at 28%, losses on loans have a big say on profitability in a given year!

And speaking of margin - it is a Thursday morning. Which means it’s time to take a look at our famous TBO EBIT Margin ranking! Below, we can see our ranking updated to include Barclays… and the UK giant slots in at 8th on the leaderboard!

In fact, 3 of the top 8 spots on that chart are now occupied by the 3 financial companies we’ve covered - Barclays, Goldman Sachs and Ninety One. And it’s only really the semiconductor industry (TSMC, Nvidia, ASML) that looks like it has a better margin profile! So far that is… we’ll get onto the tech industry (Apple, Microsoft, etc) soon enough!

Anyway, let’s move on. Today, we’re going to look at Barclays’ cash profile, and have a little study of one of the most high profile banking blow-ups in recent times! Let’s dive in!

Barclays Investors: ‘Err Can You Pay Us More Dividends Please?’

So, to kick us off, let’s as always look at the waterfall chart below. Which shows us how Barclays have spent their cash from operations (CFO) since 2004. And we see something quite peculiar. In most of the waterfall charts we’ve looked at previously, we’ve seen companies either investing their cash (through capex or acquisitions) or returning their cash to shareholders (through dividends and buybacks).

But in the waterfall chart below, it looks like Barclays have made a lot of cash from their operations… but they don’t seem to spend a lot of it!

And so the question is - what are they doing with all this cash? Well, it’s building up on the balance sheet! Remember, if you’re not returning cash to shareholders or reinvesting it into the business, cash will accumulate on the balance sheet.

And the chart below shows us that this is exactly what’s been happening at Barclays. Barclays have been piling up cash. And in 2022, Barclays had a mammoth £256 billion of cash on their balance sheet!

Now, £256 billion is obviously a huge number. But I want to provide some context. The chart below shows us how much cash other companies we’ve looked at on TBO have on their balance sheet. And it’s a pretty stark picture! Barclays and Goldman Sachs have waaaay more cash on their balance sheet than any other company!

And so the question is - why do banks need so much cash on their balance sheet? Why don’t they use some of that cash to acquire other businesses? Or at least just pay out more dividends to their investors? Well, let’s find out!

Runs: Good For Humans, Terrible For Banks

Okay, so on Tuesday, one of the terms we came across was the loan to deposit ratio. This ratio showed us what % of Barclays’ deposits they were giving out as loans. As a reminder, Barclays had £546bn in deposits. And they gave out £399bn in loans. Which meant a 73% loan to deposit ratio.

But here’s a question - why don’t Barclays just go all in and give out all of their deposits as loans. And have a 100% loan to deposit ratio.

And in fact, why stop there. Why don’t they also give all the debt they raise from other banks out as loans too? I mean, it would make sense right? More loans, means more revenue for Barclays?!

And yes, that’s right. Barclays giving out more loans, would mean Barclays collecting more interest on these loans (as long as there aren’t loads more defaults!) However, there’s a problem here. And that problem is to do with spending and withdrawals. Because yes, people and businesses deposit lots of money in their Barclays accounts. But they also spend and withdraw the money in their accounts too!

Let’s say I wanted to withdraw cash from an ATM. I’m counting on there being enough cash at Barclays so that I can get my cash! Or if I wanted to buy a Big Mac from McDonald’s. I’m counting on Barclays to have the funds to pay for my burger. And so this is why banks like Barclays have so much cash on their balance sheets! They simply have to. They wouldn’t really be a bank otherwise!

Okay but here’s a question - Barclays have plenty of cash on their balance sheet, which provides cash for people’s spending and withdrawals. But what happens if LOTS of people all want their money at the same time?

I mean, we saw earlier that there was £546 billion of deposits at Barclays. But there was only £256 billion in cash. If ALL the depositors wanted their cash, Barclays wouldn’t have enough cash to give everyone would they?! Well, no they wouldn’t. And this situation is what we call a bank run!

Now, there’s plenty of examples in history of bank runs - you can check them out using this link. But for the rest of today, we’re going to focus on a very recent example. Let’s dive into how a bank run brought the demise of Silicon Valley Bank.

Silicon Valley Bank, Cause of Death: Bank Run Sprint

Okay, so the date is March 8th, 2023. Silicon Valley Bank (SVB) is the 16th largest bank in the US. And a very respected institution used by many tech startups.

2 days later – on March 10th, 2023 - Silicon Valley Bank is bankrupt. Now, how on Earth did that happen?

Well, the story actually starts quite positively. From 2019-2022, the venture capital market is burning hot and SVB’s customers (mainly tech startups) fundraised billions in cash from VC investors. Now, where do they put all this cash? In their SVB bank accounts! So, from 2019 to 2022, SVB’s deposits rose from ~$50bn to $200bn. Happy days!

Now, as we’ve learned from this week and the Goldman week, what do banks do with their deposits? They (i) create loans and (ii) have cash at the central bank! And so that’s what SVB did. The bank gave out a bunch of loans and bought a load of US government bonds (which by the way is what we mean by ‘having cash at the central bank’). But where things start to go pear-shaped is when interest rates start to rise...

… because when interest rates rise, the value of bonds fall (check this link out if you’re wondering why). So the government bonds SVB bought started losing a lot of value. That’s obviously not ideal, but it’s not a huge issue… yet. The issue becomes more real when SVB’s customers (mainly tech companies) start feeling the impacts of the tough economic environment. Suddenly, VC investors aren’t giving them cash. These tech companies are spending more money than they’re receiving in funding. And as the chart below shows, total deposits at SVB started to fall from early-2022…

So, here’s the situation - most of SVB’s deposits are either in the form of loans to customers or government bonds. SVB’s customers are seeing less money in their bank accounts - and hence SVB’s deposits are falling more than they expected. So what does SVB do to just protect their balance sheet a little bit – they decided to sell their government bonds!

However, because the value of their bonds had gone down because of the higher interest rates, SVB made a big loss (~$1.8bn) when they sold their bonds! And this left them a little short on funds. Still not a huge problem though. They could get some wholesale funding (debt from other banks) like we see Barclays and Goldman do. And in fact that’s what they did and communicated! On March 8th 2023, SVB released a statement - which basically said ‘Hey everyone, just letting you know that we lost a bit of money due to the rising interest rates impact on our bonds and so we’ll be raising a bit more money. But no big issue’.

FT article reporting that SVB were intending to raise $2.25bn to make up for their losses

However, what followed this statement was absolute carnage! The stock market became worried that SVB may not be as rock solid as they thought. The company’s stock price collapsed 60% on March 9th! Tweets from Peter Thiel and other leading VC investors telling customers to get their money out of SVB made the fears even more real. And when SVB’s CEO told investors and customers not to panic on Thursday morning…

… everyone panicked! On March 10th, SVB’s customers withdrew an incredible $40 billion from the bank! And the following day, there were withdrawal requests for another $100 billion! And by then, SVB was taken over by California state regulators.

In a blink of an eye, SVB was gone! The 40 year reputation had evaporated in 40 hours. And this example just shows how important trust is for a bank. As we said earlier, banks don’t carry with them all the cash that depositors have given them. Like Barclays - they have £546 billion in deposits. But only £256 billion in cash. So, if all the depositors rushed to withdraw their money, pretty much every bank on Earth would be screwed! Fortunately, that mass withdrawal doesn’t happen often though!

If you want a really simple, easy to follow video that explains the SVB bank run far better than me - I highly recommend watching this 7 minute video from the Wall Street Journal - it’s very, very good!

9th Nov 2023

Nigel Jacob CFA