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Barclays - investment bank booms and lending spikes

Nicholas Hyett, Equity Analyst | 29 April 2020 | A A A
Barclays - investment bank booms and lending spikes

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Barclays plc Ordinary 25p

Sell: 139.62 | Buy: 139.72 | Change -1.60 (-1.13%)
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Total income rose 19.6% in the first quarter to £6.3bn, as trading income from the investment bank more than doubled. However this was more than offset by a £2.1bn provision for bad loans (credit provision) with profit before tax down 38.4% to £913m.

The bank confirmed that it will review its dividend policy at the end of the year, but dividends remain suspended until then.

The shares rose up 5.4% in early trading.

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Our view

You could be forgiven for wondering what all the fuss is about at the moment.

Loans to customers have grown, more than offsetting the effect of lower interest rates on loan profitability. Volatile financial markets are generally good for banks' trading businesses, and Barclays' investment bank has been no exception. That's provided a useful boost to profits just as allowances for bad loans increase - helping to keep profits positive and capital growing.

However, we worry about the longer term.

The recent flurry of investment banking and trading activity will continue for some time, but eventually it will have run its course and attention will return to the banks more traditional lending activities.

The move by the BoE to cut rates to just 0.1% in March (a record low) is also bad news for the sector. The lower interest rate will largely be passed onto borrowers thanks to a combination of base rate tracking loans, competition and regulatory action. But the interest banks pay to savers is already on the floor. With little room to push funding costs lower the net interest margin (the difference between what the bank can make on loans and pays for funding) will be squeezed. That will significantly reduce the profitability of loans.

The increase in lending has been driven by loans to corporate customers that have drawn down credit facilities as they seek to improve liquidity. That's a one off boost which will now have run its course. If economic uncertainty persists demand for new loans will fall as high street and commercial customers retrench.

The exception of course is those customers in financial difficulty. Credit cards tend to be fully drawn before a customer's goes bankrupt, as does the corporate equivalent. That could lead to a spike in bad loans above and beyond the provisions made today, even if the government does underwrite a significant chunk of emergency lending.

Increased lending is stretching the bank's key credit ratios even though overall capital levels have improved. These capital ratios are calculated by dividing available capital by 'risk weighted assets' or 'RWAs'. As loans to customers increase, RWAs increase and capital ratios fall (even if available capital remains unchanged).

In this environment it's perhaps no surprise regulators have insisted banks suspend dividends to preserve capital. The months ahead look set to be tough for the sector.

Fortunately there's some good news hidden among the doom and gloom. Banks generally are significantly better capitalised today than they were before the financial crisis. While the next few months will be difficult that should allow the sector to hopefully weather the storm without the painful bailouts of last time around.

Generally we think Barclays is among the better placed names at the moment. The investment bank makes the group more diversified, and sets it apart from some of its more UK high street focused rivals.

However, the length of lockdown and strength of the eventual recovery will determine the extent to which the bank has to wind down its capital reserves. Until those reserves are adequately replaced the dividend is likely to stay on hold.

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First Quarter Results

Net interest income rose 3.2% year-on-year to £2.3bn. That reflects a 4.4% increase in loans & advances to customers, partially offset by a lower net interest margin (NIM) - the difference between what the bank charges on loans and pays for funding - which fell to 2.91% (2019: 3.18%). Increased lending was driven by the corporate bank - with personal Barclaycard lending actually down year-on-year.

Fee, commission and other income rose 32.0% to £4.0bn, with fixed income trading income in Barclays International driving most of the improvement. The investment bank also benefited from growing in banking fees in debt and advisory.

Barclays International accounted for the majority of the new credit impairments (£1.6bn) with £481m of impairments in Barclays UK. That primarily reflects the estimated impact of the coronavirus outbreak, but also exposure to low oil prices and some specific clients. The group benefitted from government support for some loans - which reduced overall impairments.

Group operating costs remained broadly flat year-on-year, as lower costs in Consumer, Cards & Payments offset an increase elsewhere. Income growth meant the cost:income ratio improved to 52% (2019:63%).

The bank's CET1 ratio fell to 13.1% at the end of the quarter, from 13.8% at year end. This reflects an increase in Risk Weighted Assets (RWAs), with total tier 1 capital actually increasingly slightly during the year. The RWA increase primarily reflects loan growth in corporate banking as customers drew down on existing facilities.

The group expects Barclays UK and the international Consumer, Cards & Payments business to experience significant headwinds from lower rates and the economic slowdown caused by the pandemic. However, given the conditions the bank is unable to give guidance for this year or the coming quarter - although revenue in April is well ahead of the year before. The group continues to believe a long term goal for a return on tangible equity (RoTE) of over 10% is appropriate.

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