MARKET COMMENT
Don't Write Off The Banks Just Yet

By David Kuo (TMFDragon)
December 3, 2002

The news delivered in the trading update from Barclays (LSE: BARC)(NYSE: BCS) this morning should not have come as any great surprise to the market, but it seemed to. Shares in Barclays fell some 6% lower to 425p after the UK's fourth biggest bank warned that full-year profits would come in at the lower end of expectations. Other banks fell in sympathy with Royal Bank of Scotland (LSE: RBS)(NYSE: RBSPRK) 3% lower at 1586p and Lloyds TSB (LSE: LLOY)(NYSE: LYG), which is due to deliver its own trading update tomorrow, 1% down at 539p.

Matthew Barrett, the group chief executive of Barclays said, "although the trading environment remains difficult, the performance in the first nine months remained resilient." The truth, though, is that it has been a tough year for the banks and conditions are likely to remain harsh. That is until economic conditions recover.

Barclays, and the other banks, are likely to experience higher levels of bad debts. Barclays has already made higher provisions at its Barclays Capital Investment unit, which specialises in bond trading. Good income performance at this division was dented by growth in provisions leading to a flat performance compared to last year. Barclays has also made "modest" provisions due to the unrest in South America.

However provisions are only one side of the loan equation. Provisions for bad debts are a necessary consideration whenever loans are advanced. The important issue is whether those provisions for bad debts represent a significant proportion of a bank's overall lending. It is not surprising, given the number of high profile bankruptcies, that investors are noticeably worried about bad debt provisions. However, big loans are split up and passed on, known as syndication, to other banks. This means that the risks of any one company defaulting on its debts are spread over many different banks rather than being concentrated in just one or two.

Barclays is now expected to post full-year profits of around £3.2b. This compares with a pre-tax profit of £3.4b last year. That puts the shares on a valuation around 12 times earnings for 2002 (not 9 times as we mistakenly said when this article was originally published), which does not look especially expensive. Banks are a cyclical business, so as economic conditions improve, so too will their profits.