Financials Unshackled Issue 39: UK Domestic Banks - Key Take-Aways from Morgan Stanley European Financials Conference
Take-aways from the Lloyds, NatWest Group, and Barclays fireside chats at the Morgan Stanley European Financials Conference in London yesterday - with upfront summary of key themes
The material below does NOT constitute investment research or advice - please scroll to the end of this publication for the full Disclaimer
What’s in this Note?
This note presents a brief synopsis of the key themes from a sectoral perspective arising from the fireside chats with Lloyds (CEO - 09:00 BST, 18th Mar), NatWest Group (CEO - 10:00 BST, 18th Mar), and Barclays (FD - 13:00 BST, 18th Mar) executives at the Morgan Stanley European Financials Conference in London yesterday - all of which I dialled into remotely. Below this quick summary are some detailed notes (in what is hopefully a well-structured resource for you in a topic-by-topic context) from each individual fireside chat.
Please note that I incorrectly wrote in the Calendar section within the ‘Week In Review’ post of Sunday 16th March that a fireside chat with the Standard Chartered (STAN) CFO would take place at 11:00 BST yesterday. That conversation is in fact scheduled for 11:00 BST today, 19th March (the Calendar has now been corrected and you can access the amended post by clicking here) and I will cover some key highlights from that discussion in brief within the ‘Week In Review’ note of Sunday 23rd March.
Overarching Take-Aways
In overall terms, consistent with the tone expressed throughout the FY24 results season, the disposition of the executives was positive in the terms of the macro and political / regulatory climate as well as in an individual bank growth and targets delivery context.
Key Broad Sector Themes:
Macro backdrop conducive to further loan growth (retail, business) and deposits growth. All businesses positioned differently. LLOY sought to, again, drive home the message that it is particularly heavily exposed to the key growth areas of the UK economy (e.g., housing, pensions, insurance), also serving to highlight its substantial other operating income (OOI)-generative activities. NWG clear that it stands to benefit from positive activity levels too and evidenced returns delivery has been stellar in its case. BARC highlighting again the opportunities it has to expand in the UK by leveraging its recent acquisitions (as well as IB RoRWA enhancement potential and untapped opportunities for its US Cards business).
Political / regulatory environment favourable with the pro-growth Labour government pushing hard on the regulatory loosening front to support UK growth and competitiveness - ‘a lot is in the ether’ but ‘proof will be in the pudding’.
Confidence across the board in the context of both FY25 guidance achievement (hardly surprising at this early stage) and medium-term targets delivery, with plenty of supporting commentary explaining why.
Very strong visibility on structural hedge income over the coming years, a major revenue resilience factor in the context of an expected declining rate backdrop.
Deposit mix (i.e., ‘churn’ or ‘flow to term’) has stalled with just some marginal movement out of current accounts into demand product noted.
Some compression in mortgage spreads observed but swap rate volatility meant that was inevitable and confidence that completion margins will settle again in that c.70-75bps territory.
Major focus on operating cost efficiencies in the case of all three banks.
No observed deterioration in credit performance across any of the UK or overseas books at this point.
Strong double-digit RoTE targets can be delivered and will facilitate continued strong shareholder distributions. NWG is the clear leader of the pack here. View expressed that buybacks still make sense at current valuation levels. Capital optimisation also in focus.
M&A appetite is there for acquisitions if a target presents compelling value and/or can deliver strategic benefits faster than the alternative organic route - but price is a key factor and hurdle rates are high given organic returns capability.
Lloyds CEO Charlie Nunn (09:00 BST 18th Mar): Take-Aways
Overarching growth focus
The key highlight for me in this session was the emphasis placed by Nunn on the growth momentum in the business, which gives management the confidence that it can hit its targets. Consistent with the FY24 results presentation, the CEO hammered home the point that LLOY is purposefully focused on driving continued growth in lending and fee income segments that are most exposed to high economic growth (e.g., housing, Project Finance & Infrastructure, Mass Affluent) - which also serves to message a key point that the CFO William Chalmers was seemingly keen to convey at the Barclays and BoA conferences last Autumn, which is LLOY’s meaningful and growing non-interest revenue focus. The ultimate objective here seems to be to present to the market a bank that can grow interest-earning balances and fee income at a faster clip than UK GDP growth right into the longer-term - owing to its selective positioning in key growth segments. That, together with improving operating leverage expectations, is conducive to strong earnings growth delivery.
As an aside, Nunn reminded us that consensus estimates for FY26 earnings have strengthened significantly following the procurement of fresh guidance at the stage of the FY24 results - a likely prospect that I fleshed out a bit in Financials Unshackled Issue 13 here last October (following the 3Q update) owing to seemingly slightly conservative FY24 revenue guidance at 3Q as well as potentially lower forward-looking AQR analyst estimates post-FY24 results.
In overall terms Nunn remarked that, despite the ongoing dialogue around stretched government finances, households and businesses are displaying strong resilience - which, in turn, means that LLOY is operating in a resilient steady low growth economic backdrop - which is supportive in a deposits growth, mortgage lending growth, and a business lending growth context.
Reflecting in more detail on the growth opportunities, the following specific comments made by Nunn were noteworthy:
UK Net Interest Income (NII) growth: Clearly supported by structural hedge income and Nunn referred to the very specific guidance provided by the CFO at the stage of the FY24 results in this vein (i.e., expected £1.2bn and £1.5bn y/y growth in hedge income in FY25 and FY25 respectively) rather than get into an elaborate discussion on the point - though he did reiterate that structural hedge notional visibility (and, therefore, income visibility) is supported by savings growth, noting that LLOY has been winning share in both personal current account (PCA) and business current account (BCA) markets.
Mortgage activity buoyant: A positive message here with Nunn taking then opportunity to remind the audience that underlying growth in mortgage balances (i.e., adjusting for securitisations) in FY24 was considerably greater than headline growth of c.2% and that LLOY maintained flow share of >20% through all of 2024 - something which it has not delivered for many years. More importantly, Nunn referenced positive market conditions in the YTD - with activity remaining strong - which is not entirely attributable to the impending stamp duty changes in his view, particularly given that activity has remained buoyant over the last few weeks. He further noted that LLOY has previously observed improved demand on the back of official rate reductions and that he expects that to play out in response to further BoE base rate cuts (LLOY’s guidance assumes two further rate cuts in 2025).
Business lending: On corporate and commercial lending, the CEO noted that most businesses are seeing cashflow growth with the exception of some pockets within large corporates and SMEs. However, he did acknowledge that business confidence took a hit late last year and that investment has remained sluggish in response to the higher for longer rate backdrop - though further rate cuts could be helpful I guess. Business lending specifically did not form a significant part of the discussion.
Sustainability of strong other operating income (OOI) growth: Much focus on this again - like at the FY24 results session. Nunn believes that recent growth rates are broadly sustainable, noting that growth rates of 8-10% p.a. or more are deliverable. He emphasised the broad-based nature of OOI growth and the continued focus on diversification, the bias of LLOY’s OOI-related activity towards the higher-growth areas of the economy, and its determination to eke out further market share gains - though he tempered the message by stating that not every single initiative will drive growth. He also reminded the audience that there has been some ‘noise’ in the reported numbers - with volatility in: i) the operating lease depreciation line given used car price volatility; and ii) the implementation of IFRS 17 in 2022 (though he noted that the revised insurance contracts accounting approach in which CSM revenues are recognised annually implies better visibility (or, perhaps, reduced volatility) on a look-forward basis following the initial ‘noise’ at the stage of the new accounting standard’s implementation). Nunn also got into some detail on where LLOY is specifically delivering strong OOI performance / eking out OOI growth - e.g., retail (leading transport finance and leasing business; leader in EVs financing which are still growing above market-wide auto sale growth rates in the UK), insurance (workplace pensions, annuities, pensions, life, home insurance; Scottish Widows Trustpilot score improvement), CIB (untapped growth franchise with a simple strategy and at low risk, leveraging relationships with counterparties who LLOY doesn’t compete with globally in the case of its STG business, leader in UK Project & Infrastructure Finance), and other growth sub-segments like Lloyds Development Capital (LDC) and Lloyds Living.
Net interest margin (NIM) dynamics
Readers will be aware that LLOY has now moved away from procuring annual NIM guidance, instead guiding on Net Interest Income (NII) in absolute terms. Not the first bank to do this and understandable given the whole host of volume and pricing dynamics that underpin NIM - and it also serves to reduce the probability in sessions like these of getting badgered with a tonne of questions on q/q margin unbundling. That being said, a few comments on margin experience were noteworthy: 1) Nunn reiterated that LLOY passed through c.50% of base rate increases to deposit pricing on the way up (a little less than peers) and expects a similar passthrough rate on the way back down - and all is going to plan thus far. My own sense is that there is some prospective upside to this deposit beta assumption as LLOY and peers seem much less likely to be subject to Treasury interventions, FCA interventions under consumer duty, and abrupt NS&I moves in today’s - changed - regulatory backdrop. 2) Mortgage spreads in the first few weeks of FY25 were a bit tighter than the c.75bps completion spreads seen in FY24 but the counterbalance is that deposit volume growth was stronger than expected.
Efficiency initiatives
This came up in the Q&A and Nunn reiterated that LLOY manages costs very strongly - noting that the c.3% headline growth in operating expenses (opex) in FY24 would have been a reduction if you strip out the impact of regulatory changes and investment spend. He went on to briefly highlight the longer-term cost efficiency opportunities, noting that there should be scope to continue to drive improved operating leverage post-FY26 (note that LLOY is targeting a <50% CIR for FY26). Nunn noted that LLOY has significantly improved its use of technology in recent years and that GenAI will be a significant lever in the context of medium to longer-term cost management. It is worth consulting the transcript of the FY24 results call here for more elaborate detail on LLOY’s investments in this context.
Motor finance-related commentary
Nunn reinforced that LLOY’s current £1.15bn provision is its best estimate (he also reminded that LLOY paid down to its 13.5% CET1 capital ratio target for FY24 which should give confidence that this indeed is a thorough best estimate). He thinks we will likely learn of the Supreme Court decision (the Supreme Court is set to hear the appeals to the late 2024 Court of Appeal decision over the 1st through 3rd April period) within three to six months of the hearings. Obviously the end-state outcome is highly contingent on the Supreme Court decision but Nunn made two important points as follows: i) so far there has been no evidence of consumer harm; and ii) dealers now provide clear disclosure of commissions which consumers are required to sign to acknowledge in the wake of the Hopcraft judgment and Nunn made the point that there has been no observed change in customer behaviour on the back of these changes. These are indeed interesting points and it is worth remembering that, despite last week’s FCA Statement, the regulator has not definitively said that it will run a customer redress programme if the Supreme Court reverses the Court of Appeal judgment.
Regulatory perspectives more broadly
Nunn noted that “incredibly constructive announcements” that are coming from Downing Street, including yesterday’s update to the effect that Treasury has launched a review of the Financial Ombudsman Service (FOS). He further remarked that the spirit underpinning government’s various actions / reviews is that growth in the economy is paramount, the financial services industry is critical to growth delivery, and the currently calibrated regulatory regime is effectively an obstacle to growth and competitiveness. This point also came up in the Q&A in the context of UK Finance’s Plan for Growth (published yesterday here) and, while Nunn understandably wouldn’t comment on specific proposals he repeated the overarching messages (as articulated above) and made the point that there is a strong push from government to have more predictability and stability in a regulatory context, particularly with respect to conduct regulation. Nunn also sensibly took the opportunity here to repeat that LLOY is “right at the centre” of all the growth areas that have been identified by government, i.e., a very deliberate carefully constructed strategy.
Balancing capital return and M&A
In response to the analyst’s question here, Nunn made the point that, while LLOY will continue to examine prospective infill or strategic acquisitions (like Embark and Tuskar), organic growth is the primary focus. He went on to remind the audience the highly significant quantum of distributions procured to shareholders in the form or ordinary dividends and share buybacks on a three-year lookback.
NatWest Group CEO Paul Thwaite (10:00 BST 18th Mar): Take-Aways
Positive growth momentum across the business
Thwaite kicked off by reiterating that FY24 was a strong year in which NWG met and/or exceeded all of its guidance - and remarking that the three customer businesses are showing continued strong growth momentum facilitated by lending activity, deposit build, and broader growth factors like assets under management (AUM) expansion. Indeed, the lower share count has supported strong growth in eps, dps, and TNAV per share. The overall message is one of confidence in the growth outlook.
Getting into some more detail from an enlargement standpoint, the following discussion points were noteworthy:
Supportive government / policy agenda: Thwaite noted again that the Labour government is a pro-growth cabinet and recognises that the wider financial services industry (and, within that, banks) is a key conduit to unlocking the growth potential of the UK economy. He welcomes the supply-side reforms that government is effecting (e.g., planning, infrastructure, housing) and believes that these will be constructive for medium-term growth - for which he characterises NWG as well-positioned given its significant focus on housing and Project Finance & Infrastructure. It is also worth mentioning that, during the Q&A the topic of potentially increased government defence spending cropped up, and Thwaite noted that this is supportive in a NWG growth context (reminding us that the bank already has a number of defence clients within its large corporate loan book) but that it will take time to evolve (in the context of government budgetary changes taking effect and as contracts get rewarded following intensive procurement processes, etc.).
Regulatory backdrop a source of competitive advantage for the UK: Similar message here to LLOY, with Thwaite sending a measured message complimenting high-quality regulation as a source of economic competitive advantage, though, rather unsurprisingly, marrying up that observation with a view that it needs to be consistent and aligned with international regulation. He welcomed the recent positive changes in a capital context. While he noted that much potential positive change appears to be in the pipeline from a prudential and a conduct perspective (e.g., mortgage affordability measures relaxation, the wealth advice boundary) particularly and that the overall spirit of the discussions in this vein seems constructive, “the proof is in the pudding” (over to you Reeves!) - and referenced the uncertainty in the context of end-state CRD IV risk weights as a specific measure in need of addressing, by way of example.
Deposits growth has been strong; will likely slow - but an upbeat message overall: On deposits, Thwaite noted that FY24 growth achieved was ahead of management expectations and that, importantly, this growth was delivered across different businesses. He expects that household savings growth will slow this year as wage inflation levels settle.
Broad-based loan growth delivery and momentum: Very pleased with the broad-based loan growth reported in FY24 (+3.5% y/y growth in net loans), which represented NWG’s sixth consecutive year of loan growth and sees positive growth potential across NWG’s stable of businesses in a forward-looking context. He particularly highlighted the strong loan growth delivered in its Commercial & Institutional (C&I) book (+9.4% y/y excl. lending under government schemes) which was achieved whilst maintaining a single-digit cost of risk print for a second consecutive year - and he went on to flag that the growth in this book was reflective of growth across all sub-segments, i.e., roughly one-third of the growth originated from mid-market lending (credit facilities, asset finance, trade finance) while two-thirds related to large corporate lending (highlighting Project Finance & Infrastructure and sponsors activity). On mortgages, while Thwaite noted that management made a conscious decision to limit lending appetite in FY24, it was a tale of two halves with strong growth seen in 2H24. He went on to confirm that mortgage volumes have been good in the YTD and that he expects continued strong volumes for the rest of the year, though cautioned that it will remain a competitive market. Finally, Thwaite referenced the strong growth NWG has seen in Unsecured lending growth. In overall terms, I don’t think it was as forceful an argument as LLOY is making in a positioning context though NWG’s growth and returns delivery has spoken for itself.
Revenue guidance question
Thwaite was questioned by the analyst on whether FY25 revenue guidance is too conservative. For clarity, NWG has guided that revenues excl. notable items is expected to be in the £15.2-15.7bn range for FY25 while consensus (based on latest company-compiled consensus estimates as at 17th March) is already for £15.75bn, i.e., slightly above the top end of the guidance range.
NWG’s NII guidance is predicated on three further cuts in the bank base rate this year. Thwaite did not get defensive on the guidance, noting that NWG has confidence in its ability to achieve organic growth and that the outcome will depend on the macro - and, seemingly, in a bid to bring some light humour to the mix, he noted that the guidance range (rather than one specific number) helps NWG management meet its targets. In any event, NWG is again taking a more conservative approach to peers (BARC, LLOY) on where it expects the base rate to fall to in 2025 and it appears that analysts are likely and reasonably taking a different view, using sensitivity disclosures to support their modelling assessments.
On other operating income (OOI), Thwaite noted that while 2H24 saw very strong performance, reflecting the benefits of volatility in the NatWest Markets (NWM) business, management does not want to assume a repeat of those dynamics - though it was encouraging to hear that performance in the YTD has been “very strong”.
Net Interest Income (NII) dynamics
A few points of note made by the CEO in a NII dynamics context are worth picking up too:
The benefits of structural hedge income growth over the coming years are expected to offset the adverse impacts accruing from lower base rates.
Deposit mix is now stable (apart from a small notable shift out of current accounts into demand accounts) and NWG expects a weighted average deposit beta of c.60% on the way down. Thwaite further observed that, to date, the pricing response to base rate changes across the market (incl. challenger banks) has been very rational.
On mortgage spreads, Thwaite commented that swap rates have been volatile in the YTD but that NWG is comfortable writing new business around its target completion spread of c.70bps.
Focus on simplification - efficiency drive
Simplification is a key priority for the leadership team. This is much broader than just investment in technology and is a wide lens through which the management team looks to deliver improved customer / client experience, improved risk management processes, etc. By way of a specific example, management thinks it can decommission c.600 applications, which would represent a substantive saving. There is a recognition at the most senior levels in NWG that European banks have similar business models but lower CIRs and that getting the NWG CIR down to similar levels is something to aspire to. For clarity, Thwaite noted that cost guidance captures all expected efficiency initiatives.
Positive messaging on credit quality
Thwaite reminded us of asset quality trends and expectations, i.e., a cost of risk (CoR) print of just 9bps in FY24, FY25 guidance for CoR of <20bps, and an end-FY24 stock of PMAs of £299m (incorporated in the £3.4bn ECL balance sheet provision). He characterised current credit performance as exceptionally strong and that no deterioration has been observed - and, fundamentally, he observed that strong sectoral asset quality is a function of: i) post-GFC balance sheet risk reduction; ii) a cautious stance amongst UK businesses in terms of financial leverage appetite; and iii) the advent of non-banks stepping in to service higher risk lending propositions (these factors are clearly interrelated). However, on the question as to whether widening NWG’s risk aperture is desirable, he remains to be convinced that doing so would be rewarded from a stock valuation standpoint (indicating some hesitation here irrespective of prospective RoRWA inflation) - though he caveated that by saying management will take advantage of tactical opportunities (selectively), citing growth in the Unsecured lending and the Project Finance & Infrastructure books as examples while commenting that none of this is reflective of a change in “risk posture” and that the ethos is one of hypervigilance.
Capital deployment considerations
Similar to LLOY, the message here is that organic growth is the main focus and that there is ample runway to grow in each of its three business segments. On surplus capital deployment, he noted that the decision to move from a 40% to a 50% dividend payout was strategically timed (given the government’s impending exit from the register) which makes a lot of sense, that there could potentially be one further directed buyback transaction before the State falls off the register, and that there is further potential for regular buybacks - which he believes makes sense “at the current valuation level” though the way in which he tackled this question suggested to me that it has become a matter of live debate at Board level. Of course Thwaite didn’t rule out further inorganic growth initiatives either where a target business presents very compelling shareholder value and/or strategic congruence. However, he went on to comment that, given the returns that NWG is generating, it is: i) a very high financial bar relative to deploying the capital for organic growth purposes and/or returning it to shareholders; and ii) a very high operational bar in terms of management distraction. On the topic of Wealth Management opportunities specifically, he repeated that the high valuation multiples at which these businesses trade represents a real obstacle to M&A but, in a wider growth agenda context, he reassured that NWG is strongly committed to growing that business organically with its new Wealth leadership team highly focused on achieving that (interestingly, he later noted, in the Q&A, that both Coutts and the NatWest brand itself have clear opportunity to grow the Group’s presence in the Mass Affluent market).
Barclays FD Anna Cross (13:00 BST 18th Mar): Take-Aways
Progressing nicely towards strategy delivery
Barclays’ (BARC) Finance Director (FD) Anna Cross opened with some reflections on how BARC is meaningfully moving towards the delivery of its 3-year strategic objectives, highlighting the progress made by the Group in FY24 with: i) £13bn of the £30bn of additional RWA allocation to its highest-returning businesses (UK focus) delivered; ii) approximately one-third of the reduction in proportional RWAs attributable to the Investment Bank (IB) achieved (evidenced in the reduction in IB RWAs as a percentage of Group RWAs to 56% at end-FY24); and iii) £1bn of gross cost efficiency savings realised. Cross then noted that further progression is expected in FY25 and refreshed on select FY25 guidance to support this point: i) strong growth in UK Net Interest Income (NII) to c.£7.4bn; ii) CIR to reduce by c.1pp to c.61%; and iii) Statutory RoTE to increase from 10.5% in FY24 to c.11%, which is a further ‘stepping stone’ in the context of the FY26 >12% target. A discussion then followed in relation to the three disparate businesses under the BARC roof.
Barclays UK (BUK): Upbeat message in terms of growth capability
A few key messages on the UK business were conveyed, as follows:
Constructive macro backdrop supportive of growth agenda: FY24 surprised to the upside and Cross noted that the UK is marked by a stable economic environment and political stability. She remarked that BARC is seeing mortgage volume growth underpinned by real wage growth and house price inflation (demand side) as well as BARC’s strengthened appetite to leverage Kensington to grow its share of high LTI lending (supply side) - noting that 15% of FY24 originations were at high LTIs versus just 9% in FY23. BARC still sees caution in a consumer spending context but high frequency data / recent indicators (e.g., discretionary spending growth outpacing spending on essentials in January and February; 4Q24 credit card spending growth running that a faster clip than debit card spending growth) are positive indicators for growth.
Tesco Bank acquisition enhances the UK proposition: Cross recapped the strategic benefits accruing from the acquisition of the Tesco Bank retail banking business (which completed on 1st November 2024), going into some detail here, as follows: i) moves BARC away from a single-brand focus to a multi-brand strategy, which facilitates a more sophisticated and diversified product proposition (Cross also referenced Kensington in this vein); ii) presents a scalable opportunity given BARC can now directly engage with >20 million Tesco Clubcard customers; iii) brings capabilities of benefit to the wider Group - noting, for example, that BARC has historically only offered Unsecured lending product to its own current account customers and Tesco Bank’s retail banking business therefore enlarges the addressable market in that particular context; iv) synergy capture in a funding costs context, utilising BARC’s lower cost of funding; and v) synergy capture in an operating costs (opex) context with Cross giving some helpful colour here on the opportunity over time (noting that it ought to be reasonable to expect that Tesco Bank’s very high CIR of c.90% could come right down, remarking that an unsecured lending business like this should be operating at a CIR below that of BUK, which stands to reason of course given high margins - noting that BARC is focused on getting its UK cards business CIR down to c.45% from c.49% and that Tesco Bank should get down to that level too). However, there will be integration costs that drive costs up initially as articulated by Venkat on the FY24 results call.
Mooted regulatory changes are a prospective growth lever: Cross spoke about the evolving UK regulatory backdrop towards the end of the session, noting: i) the government’s pro-growth focus; ii) all mooted regulatory changes are conducive to UK growth and that the bank’s dialogue with UK regulators has been very constructive; iii) there is a recognition in the UK that the delay in the timing of the implementation of the Basel 3.1 reforms is a reflection of the relevance of how the international environment will evolve; and iv) while, naturally, Cross wouldn’t be drawn on any specifics in terms of expected regulatory changes, she did note that it “feels like there’s a lot in the ether”. It’s also worth noting that she remarked, in a broader regulatory context, that BARC has deep experience in navigating multiple regulatory environments (UK RFB, US RFB, European post-Brexit bank).
Investment Bank: Becoming more balanced; improving productivity
A few key messages on the IB business were articulated, as follows:
The IB strategy is all about becoming more balanced. In Markets, that means ‘leaning into’ Equities (Equity Derivatives particularly, where BARC has been focused on growing for some years now), securitised products trading (given the congruence with the securitised products financing business), re-strengthening in European Rates (which lagged expectations in FY24 - though a pick-up was notable in 2H24), and continued delivery in a Fixed Income context. In Advisory, Cross reiterated that the objective is to broaden the business beyond its DCM heritage to do more ECM and M&A - noting that BARC’s ECM market share was +1pp in FY24 while M&A market share was flat y/y (though market growth was strong so this was a satisfactory outcome following significant investments in talent in the prior year) - though she cautioned that this will not be a linear process q/q given the inherent lumpiness of Advisory industry revenues (indeed, Cross referenced the instructive Dealogic data, which show that ECM and M&A activity has slipped over the last six weeks owing to ongoing global market / geopolitical uncertainties and the US environment - though that volatility is a positive factor in other parts of the IB). One further point of note was Cross’s remark that BARC continues to be focused on driving strategically important USD deposits growth (which grew very strongly in FY24 following decent growth in FY23), which is helpful strategically in the context of building broader business relationships with those deposit customers.
On IB RWAs, Cross noted that they have been flat for three years now and that the business has sufficient capital to grow in the ways that management wants it to. Getting down to the target end-FY26 level of IB RWAs representing 50% of Group RWAs is a function of maintaining broadly flat RWAs in the IB while growing the UK business (there have been misinterpretations in the past to the effect that it implies IB asset shrinkage). Cross also reiterated that the focus is on improving RWA productivity in the IB and noted that the c.50% of end-FY26 Group RWAs target is not the end destination (indeed, at that point BARC will have more optionality to do various things I would note). She also gave a sense of the disciplined RoRWAs strategy - highlighting BARC’s “disciplined capital stewardship” in which management is now more intensively focused on granular client and sectoral returns analyses in deciding where and whether to allocate capital within the business and is not afraid to have the difficult conversations with clients when expected returns do not meet hurdle rates (evidenced by improving RoRWAs in the IB).
Cross wrapped up on IB capital by noting that the challenge now is achieving the right ‘velocity of capital’ rather than deciding how much capital to the IB (already done) and gave the example of how financing business is capital-light and, therefore, growing that at a fast clip is part of the IB plan.
A good question surfaced during the Q&A on downside risk in the IB given the inherent volatility in that business / the inevitability that something will go wrong in some quarter at some stage. Cross pointed to VAR as the primary monitoring tool in this respect, noting that FY24 VAR was less than FY23 VAR (though it did elevate in 4Q24, around the time of the US Presidential Election). Cross also noted that loss days have come down over time. However, it felt there was a hesitation to be fully committal that the management team’s assessment is that BARC would underperform in an improved market backdrop (e.g., higher equity prices, improved credit spreads) and outperform in a weaker market backdrop in response to a question on this (the answer was: “yes…potentially”) - though there is a lot more underneath that question (taking into account peer bank IB risk management strategies et al.) than just the more straightforward question of BARC-specific VAR / loss day trends so I suspect this was just a sensible ‘pause for thought’ on Cross’s side.
US Cards: See growth opportunity in Retail; capital optimisation focus
On US cards, the key soundings from Cross were:
A broad introductory overview comment to the effect that it is a unique highly specialised consumer credit business with c.20 very large clients - and, therefore, essentially represents consumer finance provision to BARC IB clients.
Strong growth opportunities abound. More than 80% of the balances growth that BARC has delivered has been generated organically. While partnerships are broadly locked up until 2029 (which provides strong income visibility), c.40% of card balances come to the market every year which translates into growth opportunity and there is confidence that BARC can drive increased volumes in this business. In this context, Cross went on to highlight that the US cards market is broadly 60% Retail and 40% Travel and that BARC’s business is predominantly skewed towards Travel and a better balance is desirable.
Extensive peer benchmarking work has been completed and that has been instructive in terms of what needs focus in a P&L context. A key finding from this exercise was that BARC’s US Cards net interest margin (NIM) is below peers owing to the bias of its business towards super-prime end customers and the consequently lower risk. However, it is also clear that BARC’s funding costs are much too high and its operating efficiency is not keen enough (cost per account too high). Cross also went over the reasons for why BARC chose not to renew its partnership with American Airlines beyond 2026 - i.e., the transition to a single issuer model would have meant excessive single name exposure. Additionally, given the super-prime bias of the book it is a relatively low-returning portfolio. Separately, the recently forged partnership with GM is margin-enhancing.
Further on funding costs, Cross noted the intense focus on addressing this and spoke about how the US deposit-gathering proposition has been revamped, which saw $2bn of deposit growth in 4Q alone. Additionally, the entire book was repriced in 3Q and 4Q though that will take time to feed into improved financial performance.
On opex, Cross explained that driving efficiencies is a longer-term exercise. Some progress has been made (reduced inbound call rates, improved proportion of digital interactions) but she made it clear that the business still has some way to go from a digitisation perspective, where it compares unfavourably with BARC’s UK Cards business and its previously-owned German Cards business.
The SRT transaction completed with Blackstone in 2024 involving a sale of $1.1bn of card receivables was effectively a ‘test and learn’ trade from both an execution delivery and an investor appetite context (I would add that it is also instrumental in terms of enabling continued growth with BARC’s partners in what is a heavily capital-consumptive business). Cross noted that BARC’s sense is that there is sufficient investor appetite to support continued such capital optimisation initiatives.
A question on sentiment in a US cards context popped up in the Q&A and Cross noted BARC’s Cards business has proven very resilient of late. No significant changes have been observed which is unsurprising given the super-prime bias of the book (e.g., only 12% of the book has a FICO score of 660 or less) and the fact that it has no exposure to auto or student loans currently. Purchases are still running at good levels but customers are repaying very quickly (repayments running at very high levels), which Cross suspects is reflective of broader economic uncertainties - though she made it clear that no adverse impact on credit performance has been observed, which is reassuring for now.
All in all, Cross concluded that the above points underpin management’s belief that it can deliver a 12% RoTE in FY26 and she sees the business get back to its pre-Covid c.15% returns levels in the medium to longer-term.
Efficiency is a key focus more broadly
Cross also spoke about wider operating efficiency objectives, noting that efficiency delivery is a key element of the strategic plan for each segment of the business - and that each segment has a CIR target that sits below where it lies today. She also used the opportunity here to reinforce the realism of the revenue targets, noting that Group management has deliberately created tension in the plan by running with realistic income assumptions (i.e., it would be brave to rely on income as ‘a fix’ for any cost underperformance). Following the achievement of £1bn of operating efficiencies in FY24, the target is for £500m of efficiencies in each of FY25 and FY26. The low-hanging fruit (People, Property) was plucked in FY24 so it gets a bit harder from here and a key current focus is on driving efficiencies in the end-to-end customer journeys across the group.
Disclaimer
The contents of this newsletter and the materials above (“communication”) do NOT constitute investment advice or investment research and the author is not an investment advisor. All content in this communication and correspondence from its author is for informational and educational purposes only and is not in any circumstance, whether express or implied, intended to be investment advice, legal advice or advice of any other nature and should not be relied upon as such. Please carry out your own research and due diligence and take specific investment advice and relevant legal advice about your circumstances before taking any action.
Additionally, please note that while the author has taken due care to ensure the factual accuracy of all content within this publication, errors and omissions may arise. To the extent that the author becomes aware of any errors and/or omissions he will endeavour to amend the online publication without undue delay, which may, at the author’s discretion, include clarification / correction in relation to any such amendment.
Finally, for clarity purposes, communications from Seapoint Insights Limited (SeaPoint Insights) do NOT constitute investment advice or investment research or advice of any nature – and the company is not engaged in the provision of investment advice or investment research or advice of any nature.