- Third-quarter impairments came to just £608m, against forecasts of £950m
- A strong outing from the investment bank also juiced profits
- Government support may have only delayed credit deterioration, the bank warns
When expectations are so low, the ability to pleasantly surprise increases. And so it has proved with Barclays (BARC), whose share price shot up 7 per cent after third-quarter numbers beat market profit forecasts and expected credit losses dipped 63 per cent.
The latter metric has been particularly important for shareholders this year. As well as having an outsized impact on near-term profits, it represents banks’ best estimates of the pandemic’s effects on the economy and its eventual impact on the loan book. It also sends a strong signal on how bankers view credit quality.
The bank booked £608m of credit impairment charges in the period, up 32 per cent year on year but down significantly from the £2.1bn and £1.6bn recorded in the first and second quarters of 2020. This reflects further drops in the bank’s GDP forecasts for both the UK and the US, which are now predicted to fall 10.3 and 4.4 per cent this year – versus expected declines of 8.7 and 4.2 per cent at the interim stage.
Other significant changes in macroeconomic assumptions include a delay to rising UK unemployment, which is now forecast to average 5.5 per cent this year and climb to 6.9 per cent in 2021. Even more worryingly – from the perspective of group-level profitability – the bank has downgraded its baseline interest rate forecast to -0.1 per cent for 2021 and 2022, from 0.1 per cent in June. It is perhaps the most significant acknowledgement by a major lender so far that the Bank of England may be leaning towards negative rates.
Commentary on the dip in impairments was also less sanguine. Barclays said that while “significant credit deterioration has not yet occurred”, this was largely due to the government support measures. “This is expected to delay the effects of distress and therefore increases uncertainty on the timing of the stress and the realisation of defaults,” the lender added.
Other vital signs had that ‘not quite as terrible as the last update’ glow. At £1.6bn, income from the UK business was down 16 per cent on the third quarter of 2019, but marks an increase of 6 per cent on the three months to June – the period which included the bulk of the country’s initial lockdown. That in turn meant the domestic net interest margin edged up 3 basis points to 2.51 per cent, ahead of the levels reported by each of the lender’s major UK high street competitors in the second quarter.
After a bumper earnings season for the Wall Street investment banks, expectations for Barclays International were higher than the domestic business. In the event, income of £3.8bn was only up 1 per cent year on year, despite a 29 per cent rise in profits in the markets division. However, a sharp dip in impairments here meant pre-tax profits hit £1.17bn – the best performance since the second quarter of 2019.
There was decent news on capital, too. The group’s common equity tier-one ratio climbed 40 basis points to 14.6 per cent, as the ongoing pause on dividend payments was helped by a reduction in risk-weighted assets. Chief executive Jes Staley has promised an update on Barclays’ distribution policy and dividends in the new year, pending Bank of England diktat.
Unsurprisingly, shares in NatWest (NWG), HSBC (HSBA) and Lloyds (LLOY) all rose on the prospect that their third quarter loan books might not look so ragged, either. Within that group, Barclays still has the rosiest view of UK house prices by far, and continues to model annual growth out to 2022. So far, this has actually matched the reality, though the very real prospect of a sudden contraction in the housing market could be a concern given the size of Barclays’ UK mortgage book. Shareholders should also keep in mind that consistently strong performance from the investment bank isn’t a given, even if it has helped to insulate the profit destruction so far this year.
On balance, analyst expectations for £8.6bn in net interest income in 2020 does not look unreasonable. But even with the shares at a near-record 70 per cent discount to book value, prospective investors should approach with extreme caution. The central bank appears to be warming to negative interest rates, a Brexit settlement is yet to be reached, and the pandemic’s scars on households and businesses are still only just being understood. Hold at 112p.
Last IC View: Hold, 107p, 29 Jul 2020
