OREANDA-NEWS. March 10, 2015. Fitch Ratings says that the weak 4Q14 performance of Barclays Plc's (Barclays, A/Stable/a) investment bank (IB) together with further conduct costs highlight the challenges the group faces in its restructuring process. Pressure on earnings in the IB, which generated GBP35m pre-tax profit in 4Q14 (4Q13: GBP137m pre-tax loss), was balanced by good performance in the bank's other core businesses, particularly in personal and corporate banking and Barclaycard. The results have no immediate effect on Barclays' ratings.

Barclays reported a GBP1.5bn pre-tax loss in 4Q14, excluding changes in own credit. The loss was primarily caused by a GBP935m loss following the revision of the valuation of a loan portfolio booked at fair value, a GBP750m provision relating to investigations and litigation into the bank's foreign exchange business and a further GBP200m increase in provisions for purchase protection insurance (PPI) and interest hedging redress. The loss resulting from the valuation revision of the loan portfolio did not affect regulatory capital ratios as regulatory capital already included prudent valuation adjustment deductions in prior quarters.

Adjusted for own credit changes, Barclays reported GBP2.2bn pre-tax profit for 2014, resulting in a pre-tax return on average equity of just 3.4% for the full year. Conduct costs were a major earnings drag as the bank booked a GBP1.25bn provision related to ongoing investigations into foreign exchange trading and GBP1.1bn of provisions in respect of PPI mis-selling and interest rate hedge redress.

We expect conduct costs to remain material in 2015, but the bank has demonstrated that it is able to absorb sizeable conduct costs. Costs related with the group's non-core assets will remain another drag on profitability. In 2014, Barclays Non-Core reported a GBP1.2bn pre-tax loss, of which GBP532m was in 4Q14. The group reduced exposure in the unit further by disposing businesses and exiting positions, and risk-weighted assets (RWA) fell to GBP75.3bn at end-2014 from GBP109.9bn at end-2013.

The 4Q14 performance at Barclays' investment bank was weak. The unit suffered from a 10% yoy drop in sales and trading revenue as credit trading and rates and foreign exchange suffered from weak market conditions, while equities trading results improved 2% yoy. Investment banking fees declined 8% yoy, but income from lending helped to support net revenue. The division continued to reduce operating costs in the quarter, and compensation costs declined 9% in 2014 as a result of lower headcount and a 24% reduction in incentive awards. Despite this, cost flexibility remains a divisional weakness and the cost base remains high relative to current revenues, as demonstrated by a divisional cost/income ratio of 82%. The investment bank generated a return on equity of just 2.7% in 2014, which underlines the importance to strengthen its performance if Barclays is to achieve its group level performance targets. We expect that operating expenses could be reduced further and do not believe that management is likely to increase risk appetite to improve returns.

Barclays' personal and corporate banking businesses generated GBP628m adjusted pre-tax in 4Q14, down 20% qoq as 4Q14 results included the UK bank levy and higher reorganisation costs. We expect the group's retail and corporate banking activities to generate sound profitability, helped by the good operating environment in the UK. For 2014, the business, which combines the group's domestic retail and international corporate and private banking businesses, generated a decent 11.9% return on average equity.

The group's strong domestic and international franchise in credit cards helped Barclaycard to generate good results, but 4Q14 pre-tax profit fell 41% qoq to GBP213m as the bank changed its assumptions on effective interest rates. For 2014, the business generated GBP1.3bn adjusted pre-tax profit, up 13% yoy, helped by volume growth. We expect the credit card business to remain resilient and to offer growth opportunities for the group. Barclaycard's operations will be affected by caps on interchange fees that are set to be introduced in the European Union later in 2015, but as these caps have been anticipated for some time and because of Barclays' relatively lower reliance on interchange fees given the size of its lending business, we expect this effect to remain moderate.

Barclays' fully-applied common equity tier 1 (CET1) ratio remained almost unchanged in 4Q14 at 10.3% (10.5% including the effects of the sale of Barclays' Spanish business, which was completed in January 2015), which is at the lower end of its global trading and universal bank peer group range. The group remains committed to reaching a CET1 ratio above 11% by end-2016. This should be relatively straightforward to achieve, but is starting to look low relative to the CET1 targets of some UK peers. The group's leverage ratio improved by 20bp in 4Q14 to 3.7% (3.8% after the sale of the Spanish business) as the bank reduced its leverage exposure, and we expect Barclays to reach its 4% leverage ratio target relatively easily.

Barclays will be subject to total loss absorbing capacity (TLAC) requirements and estimates that at end-2014 its TLAC ratio would have stood at about 24% of RWA and 8% of leverage exposure if senior term debt issued by the operating company, which the group plans to replace with debt issued by the holding company as it matures, is included.

The group now expects to issue the bulk of its debt from Barclays plc, the holding company and has started to issue senior debt at this level. Holding company issuance is currently used to subscribe for equivalent instruments at the operating company level, meaning no double leverage and we currently consider the senior default risk of the holding company and main operating subsidiary, Barclays Bank plc, to be broadly equivalent (they have the same senior debt ratings). The bank plans to maintain this policy and to change the terms of its internal senior debt down-streamed to the operating company (ie subordinate it) only when the bank will be required to do so. TLAC requirements are expected to come into force in 2019, but the European Union requirements for minimum required eligible liabilities will come into force in January 2015. Until this subordination of internal debt is in place, senior creditors of Barclays Bank plc, will not be incrementally protected by senior debt issued out of the holding company. .