Legal Costs Will Hurt Barclays In The Short Run, Still Worth $18

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Investors were disappointed when Barclays (NYSE:BCS) reported its results for the third quarter of the year late last week, as a lukewarm operating performance was marred by yet another legal charge for misconduct that spread over 2005-2012. ((Q3 2015 Results Announcement, Barclays Press Releases, Oct 29 2015)) Having incurred a whopping £7.5 billion (~$12 billion) in total costs since Q2 2011 for wrongly selling payment protection insurance (PPI) and interest rate products to customers, Barclays was forced to set aside another £290 million ($450 million) in Q3 to compensate customers who were charged improper rates on their foreign exchange transactions. As the scale of this newly revealed issue is not yet clear, investors assumed that associated costs will swell considerably over coming quarters – something that was seen in the case of the other two customer redress programs. At the same time, Barclays is yet to settle several high-profile lawsuits and has not begun the uphill task of ring-fencing its investment banking and retail banking operations as mandated by British regulators. Investors reacted adversely to all this bad news – sending Barclays’ shares 8% lower over trading on the last two days of the week.

But things were not all bad for the British banking giant in Q3, as all its operating divisions except for Africa Banking witnessed an increase in pre-tax profits compared to the year-ago period. Adjusting for one-time costs, Barclays’ personal and corporate banking business reported one of its best performances over recent years, as the bank’s sale of several low-profit retail banking units cut expenses at a higher rate than it reduced revenues. A surge in card usage and favorable exchange rate movements also helped Barclaycard post a strong operating performance. Moreover, the bank’s investment banking division bucked the industry-wide trend to report higher trading revenues compared to Q3 2014.

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All things considered, we believe that the sell-off in Barclays’ shares late last week was likely an overreaction. The changes to its business model being implemented by the bank are evidently having a positive impact on profitability, and key capital ratios remain strong. With the new CEO all set to start next month, we expect Barclays to work its way through the legal backlog at an accelerated rate early next year. That is why we maintain a $18 price estimate for Barclays’ stock. The target figure is roughly 25% ahead of the current market price.

See our full analysis for Barclays’ stock

Investment Banking Division Continues Strong Run

Barclays’ investment banking division, which includes its trading, advisory and underwriting units, generated £1.8 billion ($2.8 billion) in revenues for Q3 2015 – 9% higher than the figure for the same quarter last year. The bank reported a year-on-year improvement in revenues for most of the units under the division. Barclays’ revenues from credit and macro trading activities for the quarter were £713 million ($1.1 billion) – roughly the same as the figure for Q3 2014. This is in contrast to the notable year-on-year reduction in debt trading revenues reported by the largest U.S. investment banks last month. The equities trading desk also did well to report an increase in these revenues despite the high level of volatility in global equity markets – something that weighed on the performance of nearly all its peers. It should be noted that Barclays’ trading revenues would have been positively impacted by a stronger U.S. dollar. But this factor does not take away from the strong overall performance of the bank’s trading desks.

Card Business Extends Its Record-Breaking Run

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. Growing card usage coupled with the positive impact of exchange rate fluctuations helped revenues surpass the record £1.2 billion for the previous quarter to nearly touch £1.3 billion ($2 billion) this time around. This represents a sequential improvement of 6%, and is a good 15% higher than the figure for the year-ago period.

Although card provisions were marginally higher, and the stronger performance resulted in higher operating expenses compared to Q3 2014, the exceptionally high revenue level raised pre-tax incomes for the division to above £500 million ($780 million) for the first time ever. Notably, the division’s cost-to-income ratio also fell to 39% from the considerably higher 43% in Q3 2014 as well as Q2 2015.

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