Barclays : Q3 2022 Analyst and Investor Q and A transcript

Investor Relations

Barclays PLC Q3 2022 Results

26 October 2022

Results call Q&A transcript (amended in places to improve accuracy and readability)

Alvaro Serrano, Morgan Stanley

One question on costs, another on asset quality. On costs Anna, you've said you're not going to talk about 2023, and I don't expect you to give a hard number, but if I take your guidance for this year, it looks like operating expenses are annualising north of £16bn, considering there's likely inflation and consensus is closer to £15bn, so there's a significant delta. Are there any cost actions or anything I should bear in mind in that number, beyond obviously the exchange rate? Any actions you're able to take, or do you feel there's even more flexibility on variable compensation than in other times in the cycle?

And the second question is around asset quality. You said that you expect a trend towards through-the-cycle loss rates. Obviously, there's been some changes in the mix, increasing retail cards in the US and shrinking UK. I don't know if you can update us on what that number looks like now? And related to that, in your Downside 1 scenario, I think you've got a cumulative almost 20% correction in house prices. What impact would that have on RWAs?

Anna Cross, Group Finance Director

Let's take costs first. We guided, this year, to £16.7bn. That has an assumption embedded within it, that the fourth quarter dollar rate will be 1.12. As we look forward into next year, here's how I'm thinking about it. We would expect that, given we've seen elevated levels of L&C this year, for that to be considerably lower. However, the FX impact that we've seen intensifying through the year, you might expect annualises into next year.

So if rates stayed at 1.12, that would be about £500m of cost increase into next year. But what we have to remember is that that has a greater impact on the income line, so the equivalent to that £500m in income terms would be £1bn. So as you're updating your cost expectations, I would encourage you to think about the FX impact in income as well.

As relates to other factors, clearly there is inflation, but you've also got the investment that we've focused on, our three strategic priorities. You can see that not deployed equally throughout the bank. In terms of actions, we could clearly modify that investment plan, but to the extent that we feel that it's driving revenue growth, obviously we'd be thoughtful about doing that.

In terms of managing inflation, we do have efficiency programmes in place. You can see that, particularly in the UK, where you've got strong income growth dropping to the bottom line with minimal cost growth. So I would say consider the impact of efficiency programmes there. Obviously, also if we see a drop in CIB revenue, we've got another lever in compensation. But overall, I'll just leave you with a message that we're very focused on the ROTE target and very focused on delivering positive jaws.

In terms of asset quality, it's difficult to give you an adjusted version of that historic number. You're right, we're actively growing balances in US cards, we're seeing them fall away in UK cards, but, at the same time, you can see that the level of risk that we're holding in the balance sheet versus pre-pandemic is lower, and to some extent we're going to have to see how that pans out. It's lower because LTVs are lower. Actually, if you look at the staging, you can see that the proportion of stage one and two balances is also considerably higher than it was pre-pandemic.

And to your final point, we haven't seen pro-C(pro-cyclicality) in our RWAs yet. You're right, if there was a substantial decrease in HPI (House Price Index), we would expect that to impact the loss-given default in our capital models, and would lead to some RWA pressure. But equally, remember that within that there's the probability of default piece as

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well, and therefore you should consider that strength of customer balance sheet, as we sit here today. So we'll update on that as we see it happen, but to date, no sign.

Joseph Dickerson, Jefferies

You already answered my question on the FX sensitivity there on revenue versus costs, but on capital return, Venkat, I think you've spoken earlier this year about the conversion of earnings into buybacks and you did £500m at Q2. I guess, what held you back at Q3, given you've got clearly a reasonable capital buffer? Yes, there are some headwinds coming in Q4 from pensions and Kensington [Mortgages], but another £500m, I don't know, 14-15bps of capital, is this a management decision around being prudent or are there other regulatory considerations at play here?

C.S. Venkatakrishnan, Group Chief Executive

It's a decision which we will take in Q4. Basically, that's it. We did it at the year-end and the half-year this year, and so we will talk about that in our annual earnings.

Jonathan Pierce, Numis

A couple of questions, one on the hedge and one on the fair value through other comprehensive income. The hedge, there's another £10bn added to the notional in Q3. I don't know whether FX has any influence on the size of that hedge, but clearly in the UK bank, deposits haven't grown now for three or four quarters, but the hedge is still building. I'm just wondering, are you now fully hedged?

Thinking about headwinds in the other direction moving forwards, are you seeing any early signs of the hedged balances, particularly the 0% current accounts, starting to shift into higher rate deposit accounts, either within Barclays or to other institutions?

The second question, the fair value movements through OCI (other comprehensive income), in particular with regard to the debt portfolio, they were fairly small, actually, in the third quarter versus what we saw in the first half, despite much bigger movement in interest rates. I've always been slightly confused as to what this portfolio is, and I guess the question is, given the extent of the rate moves we're now seeing, can I ask you to give us a bit more detail on why you have this seemingly unhedged debt pool? And can I infer, from the relatively limited impact in Q3, that you've reduced the sensitivity to rate movements fairly significantly over the course of the last quarter or two?

Anna Cross

On the hedge, the movement, quarter on quarter, is not a sterling movement. It actually relates to euro rates, central bank rates have gone from negative to positive. It's a change in eligibility. So it doesn't impact the UK sterling part of the hedge at all. So you're right, UK liabilities are broadly stable. We are seeing some take-up of savings products but actually in a positive way, completely in line with our expectations. We've got some good savings rates out there, and so we're seeing customers migrate to those, as we expected them to. And all of that within our hedge assumptions, and the way that we created a buffer in that hedge.

As relates to your fair value through OCI question, I can see why you might have expected a larger impact. If you look at the disclosure in the annual report, that gives an amount for a 25bps shock, and I guess your question relates to the fact that the gilt curves moved by more than that. What's going on here is, firstly, the disclosure in the annual report actually includes not only the liquidity buffer but shows the impact on the pension fund assets, because the pensions [are] in surplus, those movements are obviously neutral to capital, so you're not seeing that go through.

In relation to the liquidity buffer itself, a couple of things. Firstly, the portfolio is diversified, it's not just gilts, so there's a range of products in there. And secondly, we have taken down that risk, we've reduced outright risk as the year has progressed, and it's that really that's giving the smaller result in the third quarter.

Rohith Chandra-Rajan, Bank of America

Congratulations on a record FICC performance in the quarter. Just on that, you discussed, Anna, in your comments, [that] volatility's particularly heightened at the moment, and you'd expect trading revenues, overall, to decline over time, so in terms of helping us to think about the offsets to that, you mentioned FICC financing. I don't know if you can help us with what sort of proportion of FICC revenues that is, and how that's grown, year on year or over time? You mentioned the 30% increase in balances and wider margins, but just in terms of the revenue contribution?

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And then more generally, just how we should think about CIB revenues over the medium term versus very strong revenues for the last few years. So if trading income declines, what are the offsets to that, and how should we think about the medium term?

And then the second area is just on asset quality. US cards arrears, particularly 30 days, picked up in the quarter. I don't know if there's anything that you'd want to highlight there in particular? And then back on your Downside 1 scenario, you've already talked about the 20% HPI impact, so if I understand correctly, your current reserves effectively are equivalent to something like a 2.5% GDP contraction, 6.5% unemployment and 18% to 20% HPI. I just wanted to confirm that that's the case. And then also, how quickly you think provisions normalise, what would be the drivers for that?

Anna Cross

We are pleased with FICC, that's our third quarter at over £1.5bn. There are a few things in there. We called out the financing revenue. As for proportion, that will move around a bit, depending on what's going through trading, so we think it's actually a less helpful [statistic], but we have seen balances grow by over 30% year on year, and spreads have widened. But more broadly than that, I think even in the slow side of FICC, we are seeing increased share pretty much across markets now. We think that's as a result of our client focus, but also the investment that we have put in the infrastructure and the talent in that business. So you're right, when volatility recedes, we might expect revenues to drop back, but they won't drop back, to levels pre-pandemic. And we think that's the most important thing.

What are the offsets to that? Well, clearly banking is having a quieter period right now. That is clearly driven by the same piece, volatility in the market gives us elevated Markets revenue, depressed banking, so we'd expect that to come back somewhat. The other piece to remember, because we always all forget, is Corporate, and particularly Transaction banking.

Transaction banking is a stable franchise business, but one that is also benefiting from the investment that we've put behind it. You're seeing balances grow, you're seeing margins somewhat wider, but also, through nominal economic activity, you're seeing trade finance, FX, etc. going through there in fees. So whilst individual pieces might drop back, Rohith, we do have, increased confidence in the whole.

C.S. Venkatakrishnan

I would echo what Anna said about confidence in the whole. I think, as rates have risen and spreads have widened, fixed-income financing, not just balances but profitability per unit balance, has increased. And it's long been part of the DNA of Barclays. We've got a market-leading position in this area. So I think it's part of a broad set of things within the Markets business that represent a diversified portfolio of activity, but I think look to this, in this kind of environment, to provide a strong amount of ballast to our returns.

Rohith Chandra-Rajan, Bank of America

Sorry, just before you move onto the cards, I appreciate you don't want to give a proportion, but can you help us scale the contribution from FICC financing?

Anna Cross

We wouldn't give that out on a call like this, Rohith. We'll continue to consider our disclosure around FICC, and indeed the other parts of Markets, and we'll come back to you on that.

On US cards, arrears have ticked up a little. Balances are growing, we're seeing increased economic activity in the US, manifesting itself in our card stock, people are spending more, we're seeing organic growth. Given that movement, from a very, very low base, we would expect to see some movement in staging and some movement up in delinquencies.

We're not concerned by what we're seeing; it looks broadly in line with the industry. It's what we would have expected. It remains quite a long way below pre-pandemic. And the fundamentals of the US economy are pretty strong. Unemployment at 3.5% and we're still seeing strong levels of repayment across that book. So no concerns now.

We've shown you what would happen if we weighted 100% the Downside 1 scenario. And we've called out for you the main macroeconomic variables that Downside 1 represents, so 6.5% unemployment in the UK for example.

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So you're right, that's the comparison we're drawing. So in other words, if we saw Downside 1 pan out exactly as we show it in that model, then we would expect to cover it with PMAs. Sometimes the macroeconomic variables don't flow exactly the way we model them to, so that's a specific scenario that we're calling there. But we feel like we're well covered

On the pace of normalisation. I guess we would expect to trend towards that 50-60bps as we grow and economic activity recovers. The thing I'd just call out for you is, given the nature of IFRS 9, that pathway won't necessarily be linear. We can see some lumpiness. So that's more a go-to position, once we see economic volatility settle down a bit.

Omar Keenan, Credit Suisse

I've also got a follow-up question on the Downside 1 scenario, and a second question on bank taxation. Firstly, on the Downside 1 scenario, thank you for that helpful disclosure. I think we can all make our assumptions of various downside cases, but GDP down 2% and unemployment at 6%, probably not as bad as you can imagine things, but it's probably a reasonable downside case for now.

So if things were to materialise in that direction, could we assume that there would be a smooth allocation of the post- model adjustments towards the modelled provisions, somewhat like we have seen this quarter? Or do you think there could be pressures to keep the uncertainty buffer at a high level, despite the macroeconomic deterioration?

And just related to that, could I ask you how confident you feel in that Downside 1 model scenario? I guess with interest rates where they are, could that affect the ability of otherwise performing exposures to pay? Just want to get a feel as to how confident you are in that modelled number, given that it is a model.

And then, the second question on bank taxes. Obviously, there's a bit of discussion around where the surcharge is going to be set. I wonder if you can give us any update there, and whether you've had any discussions with the Bank of England on reserve tiering?

Anna Cross

Good question on the impairment. We'll take that quarter by quarter. You can see what we've done this quarter, we've seen a general movement in the MEVs (macro-economic variables) and we've broadly offset that. The answer is whether or not, or where, that impairment starts to manifest itself. So, for example, in the UK retail bank, we are holding a general economic uncertainly PMA, whereas in the wholesale side of things, we're more sector-specific. So I would expect it to have some smoothing impact, whether or not it's exactly smooth, quarter by quarter, will depend where that impairment manifests itself.

In relation to Downside 1, you're right, no model is ever perfect, and I'm going to hand over to Venkat in a moment because I know he'll have a view. These models were built during periods of low interest rates, and so there is clearly an impact on affordability from inflation and from interest rates, which is difficult for those models to represent. But that's why we've been conservative in our stage one and stage two provisioning. When you look at the stage one and two provisioning across the unsecured books in particular, that's how we're trying to protect ourselves against that.

C.S. Venkatakrishnan

I think what you should look at, is the combination of the modelled output plus our extra post-model adjustment as our view of what we think is appropriate during the current macroeconomic conditions, and the uncertainty of the model behaviour. Now, if conditions change and we get less uncertainty, we will do what we just did this quarter, but we're also looking at consumer behaviour, and we will make adjustments to that, but I think you've got to expect, all other things being equal, that we would look at it the way we did this quarter.

And if I can then go to your second question, which is about taxes, and you had two parts, one was reserve tiering and the other was surcharge. On the overall taxation matter, it is something for the government and the Chancellor to decide. We read the newspapers as you do, and so we'll wait for the budget statement to know what it is. And on reserve tiering, I think the Bank of England has been fairly clear that they don't believe in reserve tiering as a tool [to control] monetary policy, so we'll go with that too.

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Chris Cant, Autonomous

Thanks for the FX colour in the slides as well, that's much appreciated. If I could just invite you to talk about your view on returns into next year? You've had a very longstanding >10% ROTE target; I think you originally gave that back in 2017 as a medium-term target. You're expecting to deliver that this year, despite obviously the shelf over-issuance charges you've taken, which are not expecting to repeat next year.

Your TNAV is dropping because of rates. You've got a meaningful FX tailwind, looking into next year. Should you not be targeting something punchier on a forward-looking view? And do you expect to be revisiting that >10% figure, please?

And then on the structural hedge, obviously we've had years of growth in the structural hedge, it's up very materially since pre-COVID levels. I appreciate your comments about some migration into savings products as an alternative to current accounts, do you expect your structural hedge notional to shrink in the coming years, please? Do you expect that size to be coming down as the yield is increasing?

Anna Cross

On returns, you're right we've made good progress towards that target for FY22, and we've delivered >10% in FY21. The target is deliberately a floor, so it's >10%, and you can see that, for a few quarters now, that's where we've set our expectations. We won't update, Chris, at this juncture. I take your point on TNAV, but given the effect on reserves of some of the macroeconomic volatility that we've seen, that TNAV number is moving around quite a lot. It's probably moved significantly since the quarter-end again, I would think. So we're not going to update at this point, but I would just note it is a floor to our expectations.

C.S. Venkatakrishnan

I think I'll repeat and echo what Anna has said, which is it is a floor. You're right, that we set it in 2017 as a medium-term target, and I'm glad we've lived up to the medium-term target, and we'll continue to think about it.

Anna Cross

When we put the structural hedge together, Chris, you'll note that we've done it over a series of quarters. We've been very thoughtful about how we've built the hedge and, at all stages, we've assessed the outflow risk versus the opportunity cost of not putting the hedge on.

We've obviously maintained a buffer for conservatism, as we've put that together. That buffer contains our expectations of product migration. If that proves to be wrong, obviously we're rolling a portion of the hedge, month by month, as well, so that gives us further flexibility, but to date, the moves that we've seen have been in line with our expectations, and we did build it conservatively, we believe.

Chris Cant, Autonomous

Did the size of the buffer that you had in scaling the hedge take into account things like large competitors offering 2.75% on instant access savings, and 4% on 1-year fixed bonds? I guess the move in rates in recent months has been very dramatic, we're talking about the UK base rate going to maybe double the level consensus would have been thinking about even three months ago, but that was part of your scaling of the hedge, you were factoring that magnitude of rates movement?

Anna Cross

As we scale the hedge, we identify what we believe are rate-sensitive balances. So in part, yes. Clearly, not the specific rates that you've quoted there, rates are moving all the time. We believe we've got a competitive savings product ourselves, and actually we're seeing little migration, in fact practically no migration, out of the bank, and migration within our expectation to those products. We do consider migration when we put the hedge together.

Martin Leitgeb, Goldman Sachs

I was just going to ask a broader question with regards to the outlook for your UK business, just specifically about the mortgage rates. Mortgage rates in the UK have risen from around 2% at the turn of the year to around 6% most

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