Will a New Bad Bank Help Barclays Like it Did at Citigroup and Royal Bank of Scotland?

As Barclays moves towards the creation of a bad bank it's important to see Barclays' strategy and how previous bad bank plays at Citigroup and Royal Bank of Scotland Group worked out.

Apr 30, 2014 at 1:44PM

This week, British bank Barclays PLC (NYSE:BCS) announced it would be creating a bad bank to house non-core assets as the bank seeks to restructure for more efficient operations.

More details on the bad bank are expected during next week's strategy review, but the creation of bad banks is hardly a new phenomenon. Here I'll look at how Citigroup (NYSE:C) and Royal Bank of Scotland Group (NYSE:RBS) have employed the bad bank strategy and what Barclays may be seeking to accomplish.

Toxic

Source: Flickr / John Morgan.

Warning: Toxic asset zone
It should come as no surprise to investors that big banks, especially the least healthy ones, were left with massive amounts of toxic assets following the financial meltdown in 2008. After all, all those once AAA-rated securities didn't just pack up and leave bank balance sheets. At the same time, major banks looked toward aggressive restructuring as the way forward and this meant the disposal of non-core assets.

Soon after the financial crisis began, Citigroup took on a version of the bad bank strategy by creating a separate unit within Citigroup called Citi Holdings. The unit is tasked with disposing of everything from mortgages gone bad to Spanish and Greek retail operations. In its most recent quarterly report, Citi Holdings still had assets of $114 billion, as the unit tries to maximize the value of the assets while shrinking Citi Holdings over time.

Closer to Barclays' home has been the creation of the internal bad bank at Royal Bank of Scotland Group. Following a 45 billion pound bailout, RBS is now 81% owned by the British government and the past several years have been rough for the bank. Seeking to restructure, RBS formed an internal bad bank last year to house 38 billion pounds in toxic assets having already formed a non-core division shortly after the crash. (The non-core division had everything from aircraft leasing to a chain of pubs which RBS looked to sell to raise capital).

While the bad banks at Citigroup and Royal Bank of Scotland Group have not made all the troubles disappear, they have made some improvements. Citi Holdings has been a drag on earnings but investors have factored this into Citigroup and the stabilization of Citi Holdings is allowing these assets to create less earnings related damage.

RBS announced it would take an impairment charge of around 4 billion pounds by realizing the loan losses for its bad bank. This, in turn, pushed RBS into the red for 2013 earnings but sets the bad bank up as a separate division more focused on the disposal of toxic assets.

Toxic

Source: Flickr / HaPe_Gera.

The Barclays strategy
Currently, Barclays does have its non-core assets in a different area of the banking group. However, as the Financial Times reports, they are not is a separate division but are instead in an "Exit Quadrant". If you don't entirely grasp the concept of an "Exit Quadrant" then you number among the many investors Barclays is trying to impress by relocating the non-core assets to a separate division.

As much as investors love dealing with "Exit Quadrants", by moving the non-core assets to a separate division, getting a picture of how Barclays performs, ex- non-core assets, will become easier based on how the bank will report future results. Although the bad bank doesn't really change Barclays' goals since the "Exit Quadrant" was winding down the non-core operations anyway, Barclays hopes it can appear better to investors as investors look past the ugly non-core assets to see the improved performance of Barclays' core assets.

A sort-of new strategy
Since Barclays already had its "Exit Quadrant" dedicated to reducing non-core assets, it's questionable how much Barclays has to gain on the logistical front by establishing these assets as a separate bad bank. The more apparent motivation appears to come in the form of showing the right stuff to investors.

By showing the healthier core Barclays results separate from the less healthy non-core Barclays results, investors can get a better look at the Barclays they're investing in for the long-term. With more details on the Barclays bad bank expected next week during Barclays' strategy review, this is definitely something both American and European bank investors should keep an eye on.

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Alexander MacLennan has the following options: long January 2015 $40 calls on Citigroup, long January 2015 $45 calls on Citigroup, and long January 2015 $50 calls on Citigroup. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool owns shares of Citigroup. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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