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Barclays - lower impairments boost profits

William Ryder, Equity Analyst | 30 April 2021 | A A A
Barclays - lower impairments boost profits

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Barclays plc Ordinary 25p

Sell: 181.02 | Buy: 181.08 | Change 2.50 (1.40%)
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Barclays reported £5.9bn in total income for the first quarter, down 6% on last year. That reflects declines at the UK Bank and the Consumer Cards & Payments division. The corporate and investment bank did relatively well, with income down just 1%.

Profit before tax rose to £2.4bn, up from £913m last year.

The bank intends to pay a progressive divided going forwards, supplemented by share buybacks where appropriate.

The shares fell 5.2% in early trading.

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Our View

Full year results marked the return of the dividend. However, it was modest compared to what we, and the market, had expected. Instead a good chunk of the returns were made through a share buyback - equivalent to 4p per share.

The choice of a buyback probably indicated a belief on management's part that the bank's shares were undervalued to some degree. However, it also gives the group extra flexibility on returns going forward. Investors tend to respond badly to dividend cuts, especially now Barclays has committed to a progressive dividend. By comparison it's far easier to flex buyback programmes to suit the economic conditions - and the outlook is still far from certain.

Recent results have benefited from ideal conditions for the bank's trading desks, as customers' trading volumes and hedging activity has increased. Meanwhile the glut of companies turning to financial markets for extra cash, whether that's through debt or issuing new shares, meant a hefty pay day for Barclays' investment bank.

That's been a crucial tailwind at a time when the core retail and commercial banking business has struggled.

Small businesses have leant heavily on the bank to provide the liquidity needed to see them through the crisis. Government schemes have seen Barclays lend an extra £11.8bn to SMEs, and while the government has underwritten potential losses on those loans, it's a sign of the stresses many businesses are under. Provisions for bad debt increased dramatically earlier in the year - and we'll only know for sure if they are sufficient when government support is withdrawn at the end of the crisis. However, subsequent provisions have been considerably lower.

Meanwhile on the high street consumer lending has shifted towards less profitable categories. While Mortgage lending has continued to increase, that's being offset by a fall in credit card or unsecured lending as consumers paid down debts. The shift towards lower risk property-backed loans is less profitable for Barclays.

Meanwhile profitability across both high street and business customers, has been impacted by the lower interest rates in the UK. The Bank of England cut rates to just 0.1% in March 2020 (a record low). Lower interest rates get passed on to 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 lending.

What we're seeing here is a classic example of a bank as an economic bellwether. When economies struggle, interest rates and demand for loans falls, even as bad loans mount. If conditions turn and the UK economy accelerates out of the crisis then those headwinds should reverse, potentially fuelling a rapid recovery.

As things stand though, Barclays has a couple of things in its favour. The first is the extra diversity from the investment bank, and we see this natural hedge as one of the main advantages of Barclays' 'Universal Bank' model. Second is a robust looking balance sheet, with regulatory capital well above the minimum requirement. Provisions for bad loans also outstrip the amount of loans actually in default - covering a reasonable chunk of the loan book - and mean the bank can weather some extra defaults without taking a hit to its capital levels.

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. The banks valuation is now only slightly below the long run average, though still below book value, perhaps reflecting the persistence of low interest rates. As things stand we see no evidence that interest rate trends are set to reverse.

Barclays key facts

  • Price/Book ratio: 0.5
  • 10 year average Price/Book ratio: 0.5
  • Prospective dividend yield (next 12 months): 3.3%

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First Quarter Results

Net interest income fell 21% to £1.9bn during the year, reflecting continued pressure on the bank's net interest margins (NIM), which were down to 2.92% from 3.26%. Non-interest income rose 2% to £4.0bn, largely reflecting increased trading fees at the international investment bank.

The bank reported impairments related to bad loans of £55m during the quarter, down from £2.1bn last year, reflecting lower unsecured lending balances. Operating expenses rose 10% to £3.6bn, driven by increased bonuses for investment bank staff. That caused the cost-to-income ratio to rise from 52% to 61%. That's slightly above the group's target.

Barclays UK reported an 8% fall in total income to £1.6bn, reflecting a 9% fall in net interest income to £1.3bn and a 1% rise in net fee, commission and other income to £295m. That reflects lower net interest margins and increased unsecured lending in Personal Banking, partially offset by growth in deposits and mortgages, and reduced borrowing and spending at Barclaycard Consumer. Despite lower interest rates, Business Banking income increased 13% thanks to higher lending volumes to small and medium-sized businesses.

Profit before tax for the division increased 136% to £460m thanks to lower expected defaults (credit impairments).

Total income at Barclays International fell from £4.6bn to £4.4bn, reflecting 1% decrease at the Corporate & Investment Bank to £3.6bn and a 22% fall in Consumer, Cards and Payments to £805m. Profit before tax increased 140% to £2.0bn thanks largely to lower credit impairment charges.

The bank decreased its CET1 (Common Equity Tier 1) capital by £0.4bn and Risk Weighted Assets (RWAs) increased by £7.2bn. As a result, the CET1 ratio (a key measure of banking capitalisation) fell from 15.1% to 14.6%, slightly above the targeted range.

The bank reported a return on tangible equity of 14.7%, up considerably from 5.1% last year, reflecting higher profits.

The bank still expects to deliver an improved return on equity in 2021 and impairment charges are expected to be materially lower. The group expects costs to increase this year due to continued investment and higher bonuses for staff.

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.

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.