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Barclays - pretty steady with modest bad loan provisions

Nicholas Hyett, Equity Analyst | 23 October 2020 | A A A
Barclays - pretty steady with modest bad loan provisions

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Barclays plc Ordinary 25p

Sell: 166.46 | Buy: 166.50 | Change -2.02 (-1.20%)
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Third quarter income fell 6.1% to £5.2bn. That reflects the effects of reduced borrowing and lower interest rates on loan profitability for high street and commercial lending, partially offset by continued progress in Barclays' trading and investment banking activities.

The bank reported a profit before tax of £1.1bn, compared to £246m in the same quarter last year. The improvement was driven entirely by £1.6bn PPI related charge taken in the third quarter last year, and comes despite a further £0.6bn provision for bad loans.

The board will provide an update on the dividend at the full year results.

Barclays shares rose 3.0% in early trading.

View the latest Barclays share price and how to deal

Our view

Banks are a bit of an economic bellwether, and that puts Barclays right at the heart of the coronavirus crisis.

Business customers have been leaning heavily on the bank, with the UK high street business increasing loans to businesses by 31.4% in the first half. And while a lot of the risk associated with these loans is underwritten by the UK government, the extra demand is an indication of the severe stress many small businesses are under. Even the larger companies serviced by the Corporate & Investment Bank have been calling on Barclays for extra cash.

That's been offset by a decline in some areas of consumer lending, particularly credit cards, but the overall effect is an increase in lending to all customers of some £5.3bn since the start of the year. However, the changing make up of lending and shift in interest rates mean overall interest income has shrunk.

The Bank of England cut rates to just 0.1% in March (a record low). Lower interest rates get passed onto borrowers through 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 is squeezed. That significantly reduces the profitability of loans.

Changes in the types of loans Barclays is making also have an effect. Credit cards borrowing comes at a higher rate of interest, and that's shrunk as consumers cut back on spending in the face of a worsening economic environment. Government underwritten business loans are far less lucrative by comparison.

It doesn't help that a higher proportion of the banks loans are also expected to turn bad. Credit cards and overdrafts tend to get maxed out before a customer goes bankrupt, as does the corporate equivalent. Barclays now thinks it will take longer for the UK to recover from the crisis, and that's led to a significant hike in bad loan provisions.

The good news is that volatile financial markets are ideal conditions for banks' trading desks, as customers trading volumes and hedging activity increases. Meanwhile the glut of companies turning to financial markets for support, whether that's through debt or issuing new shares means a hefty pay day for Barclays. This natural hedge is one of the advantages of Barclays 'Universal Bank' model. The boost will be relatively short lived though, and if the economy slides into a prolonged recession Barclays investment bankers won't escape the pain, but for now it's a useful tailwind.

More generally we take comfort from the fact UK banks are significantly better capitalised today than they were before the financial crisis. That's led the Barclays' board to suggest it's toying with restarting the dividend next year, which would not doubt be very welcome to beaten up investors . With the shares trading at a fraction of their book value, paying out even a relatively small portion of overall profits could mean an attractive dividend yield (despite a return on equity of just 3.6% so far this year).Whether the dividend is ultimately forthcoming remains a question though, not least because the regulator may retain its current moratorium on payments to shareholders.

Overall we see Barclays as offering something a little different to the rest of the sector. It's more diversified, and that has been well rewarded so far. However, there are challenging times ahead and a price to book ratio that's well below its long term average reflects genuine worries about profitability in a low interest rate world.

Barclays key facts

  • Price/Book ratio: 0.28
  • 10 year average Price/Book ratio: 0.55
  • Prospective dividend yield (next 12 months): 3.7%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Third Quarter Trading Update

Loans & advances to customers fell £0.7bn year-on-year to £344.4bn. Together with a 0.55 percentage point decline in the net interest margin (the difference between what a bank makes on loans and pays to depositors) to 2.89%, that meant overall net interest income fell 16% to £2.1bn. Lower net interest margins reflect the decline in the Bank of England base rate and a decline in higher risk, higher margin lending like credit cards.

Net fee income rose 1.7% to £3.1bn. That reflects very strong growth in trading income, up 37.7% year-on-year to £1.5bn as the bank's equity and fixed income trading desks benefitted from high levels of market volatility. That more than offset lower fees in the retail business - where many fees have been temporarily suspended to support customers through the current crisis - and reduced activity in cards and payments.

The bank set aside a further £0.6bn to provide for expected bad loans during the quarter. That reflects the groups deteriorating view of the economic outlook - although as things stand defaults remain fairly steady thanks to government support. The bank has now made provision for 12.2% of the unsecured lending portfolio - up from 8.1% at the start of the year.

Barclays' CET1 ratio - a key measure of banking capitalisation - now stands at 14.6%, up from 13.8% at the start of the year and 14.2% at the start of the quarter. The increase reflects profits in the quarter and the non-payment of dividends - partially offset by an increase Risk Weighted Assets.

The bank's CET1 ratio is now more than 3 percentage points over its regulatory minimum.

While low interest rates are expected to remain a challenge going forward, the bank generally sees things improving from here. Impairments are expected to shrink half-on-half and year-on-year. Full year costs are expected to be in line with last year.

Find out more about Barclays shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.