Barclays Reports Strong Q2 Results Despite Incurring Heavy Legal Charges

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A mix of good fortune and targeted cost cutting measures helped Barclays (NYSE:BCS) report one of its best operating performances since the economic downturn on Wednesday, July 29. [1] The U.K.-based banking giant, which recently saw its CEO ousted by the board in a bid to speed up the process of improving operating efficiency, witnessed a sequential increase in revenues while operating costs fell slightly quarter-on-quarter. On an adjusted basis, pre-tax profits improved 12% year-on-year.

Notably, Q2 2015 was one of the rare occasions in recent years when Barclays’ reported pre-tax profit figure was not far from the operating profit figure. Although the bank was forced to set aside another £850 million ($1.3 billion) in reserves for its PPI-related misgivings, the impact of this on the bottom line was mitigated by a £282 million ($440 million) accounting gain from a revaluation of its own credit, and a one-time gain of £496 million ($776 million) on Lehman assets. It should be noted that Barclays has now incurred more than £7.5 billion (~$12 billion) in total costs related to the PPI and interest rate product issues since Q2 2011 – a figure that could swell further over coming quarters.

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That said, Barclays has done well to improve revenues as well as profits for nearly all of its operating divisions compared to the already strong Q1 figures – especially for the investment banking division. Also, the efforts put into shoring up the balance sheet have paid off, as the group’s common equity tier 1 (CET1) capital ratio figure rose to above 11% for the first time. With the bank looking to work through its non-core assets at a faster pace, and with the new management eyeing a cost-to-income figure around 55% in the long run (down from above 70% now), we have revised our price estimate for Barclays’ stock upwards from $18 to $19. The new price estimate is roughly 10% ahead of the current market price.

See our full analysis for Barclays’ stock

Investment Banking Division Continues To Impress

Barclays’ investment banking division, which includes its trading, advisory and underwriting units, generated £2.15 billion ($3.4 billion) in revenues for Q2 2015 – nearly identical to the figure for the previous as well as year-ago quarters. This was the result of a strong all-around showing by all divisions, including the fixed income trading desk. Barclays’ fixed income trading desk churned out £826 million ($1.3 billion) in revenues for the quarter – 8% below the figure for Q1 2015 but 7% higher than that for Q2 2014. This is a strong performance, considering the decline in debt trading revenues witnessed by the sector as a whole in Q2 due to a marked reduction in activity levels for the months of May and June.

Despite revenues remaining largely unchanged, the investment banking division reported pre-tax income of £765 million ($1.2 billion) – a 13% improvement sequentially, and a 35% jump year-on-year – thanks to a notable reduction in operating expenses. Operating expenses fell from £1.6 billion in Q2 2014 and £1.5 billion in Q1 2015 to under £1.4 billion this quarter. This helped the division’s cost-to-income figure fall to below 65% for the first time since Q2 2013. The impact of improving operating margins on Barclays’ share price can be understood by making changes to the chart below.

Card Business Has Record Quarter

Despite the series of major changes to its business model since the economic downturn of 2008, the one division that has remained almost entirely in its original form over the years is Barclays’ card division. Barclaycard is almost exclusively focused on the U.K. and U.S., and has a strong presence in these markets – justifying the bank’s decision to not tamper with the unit. This stand was clearly the right one, as the unit notched up its best ever quarterly performance in Q2 2015 as revenues scaled a record high figure of £1.2 billion ($1.9 billion). This represents an 8% improvement quarter-on-quarter and a 13% increase year-on-year. The reason for this was a sharp increase in payment volumes, which in turn boosted fee-based income figures for the period. Barclaycard purchase volumes increased to £145 billion ($227 billion) for the first half of 2015 compared to £124 billion ($194 billion) over the first half of 2014.

Although operating expenses increased 7.5% sequentially, the fact that provisions were slightly lower ensured that the benefits of higher revenues reflected in the bottom line as a 17% increase in pre-tax profits.

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Notes:
  1. Q2 2015 Interim Management Statement, Barclays Investor News, Jul 29 2015 []