Morningstar equity analysts are lowering Barclays’ forecasts for 2017, resulting in a lower fair value estimate of 220p per share, down from 250p. This follows a weak profitability performance in the year to date, burdened by lower income generation – in both Barclays UK and Barclays International, its investmen bank – and higher costs.
While shares currently offer some upside, we believe the risk attached has increased, hence our high uncertainty rating. We still prefer Lloyds over Barclays within the UK banking space.
Looking at profit and loss trends for the year to date, Barclays' performance fell below the estimates we set for the bank at the beginning of the year. For the year to date, Barclays’ total revenue fell 2% year on year and net revenue declined 5% when compared with last year.
Within the Barclays group segment, Barclays International, especially CIB, which is Barclays' corporate and investment banking business, was the worst-performing segment. Barclays International net income declined by 15% year on year, mainly caused by a 14% revenue decline in CIB’s markets business.
Looking at the markets business in detail, this decline reflects a 27% reduction in macroeconomic income, caused by lower market volatility and the impact of an exit of energy-related commodities. Within CIB, credit impairment charges also saw a sharp increase of 21% year on year, mainly caused by increase in consumer, cards, and payments credit impairment charges. CIB's operating expenses also showed an increase of 4% compared with last year, owing to the cost increase in the consumer, cards, and payments segment, reflecting continued business growth and investment.
While Barclays UK posted a net profit increase for the year to date, we deem the top-line performance to be weak, with net interest income remaining flat and net fee income declining 15% year on year. Within the Barclays UK business, while the personal banking and wealth businesses posted 5% and 3% respective revenue declines year on year, Barclays Consumer UK revenue remained flattish thanks to improved margins. Barclays UK's total costs for the year to date showed year-on-year improvement of 5%, owing to lower charges for PPI of £700 million – versus £1 billion in 2016 – and improved cost efficiencies.
We believe Barclays, having nearly completed its restructuring plan, will be ahead of peers in terms of focusing on its core business and grabbing market share. Within two years, the bank has managed to reduce risky assets by £85 billion, which will help Barclays to improve the risk profile of the bank. However, in the short term, we believe outstanding litigation and conduct charges put future earnings at risk.
In total, the bank has put aside £8.4 billion relating to the mis-selling of payment protection insurance. While we think the downside risk to further PPI redress is limited, Barclays’ case with the US Department of Justice regarding the investigation into residential mortgage-backed securities is ongoing, and the bank has made no provisioning toward this case, which could cost billions of pounds.
While the bank is exposed to some downside risk due to Brexit, as 52% of its income is generated in the UK – 34% from the US – and more than 55% of net loans are sourced there, we believe the risk is in line with other UK-based peers. We also believe any costs that may occur due to the loss of passporting – which allows EU firms to sell products and service across borders – should be manageable, as management indicated several options that the bank is considering.
We believe Barclays’ current capital position is sufficient to absorb any short-term headwinds that may arise from litigation and conduct costs, a possible downturn in the investment banking business, or a slowdown of the UK economy due to Brexit, given its diversified business both on a geographical and a segment level.
