Barclays (LSE:BARC) shares have underperformed over the past year. The stock is down 15% over 12 months.
Several UK banks have seen their valuations fall as the economic environment has worsened. After all, these financial institutions are traditionally cyclical stocks, meaning they reflect economic fluctuations.
However, as we approach 2023, there is one big tailwind for banks… and Barclays. So let’s take a closer look.
A big reason to buy
Interest rates have been steadily increasing throughout 2022 and will continue increasing through to 2023. Last week, the Bank of England (BoE) pushed rates up by a further 50 basis points.
Now, the BoE base rate sits at 3.5% and some analysts see the base rate hitting 4% in 2023. But it could go higher, especially if UK inflation shows no sign of easing.
This represents a huge change for banks, and it’s a positive one. For over a decade, we’ve had near zero interest rates.
Higher interest rates translate to higher net interest margins. This is because banks imperfectly pass on higher lending rates to saving customers. And in the near term, this is where Barclays will accrue more earnings.
But in the medium term, we can see that Barclays has used a consistent hedge strategy for several years in an effort to smooth the impact of the interest rate changes on net interest income.
Some analysts predict that this could lead to an interest rate tailwind of £5bn in incremental revenue by 2025.
But it’s equally important to note that Barclays is currently earning more interest on its deposits with the central bank. Calculating exactly how much the bank will accrue is dependent on eligible assets held as central bank reserves.
For example, peer Lloyds had £145.9bn of eligible assets with £78.3bn held as central bank reserves as of 30 June. Analysts anticipate that each 25 basis point hike in the base rate will add close to £200m in treasury income solely from holdings with the BoE.
Buying more for 2023
There are, naturally, headwinds. For one, banks will need to put more money aside for bad debts as the economy weakens. In Q3, impairment charges for the quarter rose to £381m, an increase on the £120m a year ago.
On a nine-month basis, the charge for potential bad debts rose to £722m, compared with a £622m release last year.
However, the positive impact of higher rates is greater than the negative of bad debt provisions. Despite the impairment charges, group income rose 17% to £6.4bn in the third quarter, driven by increases in interest rates. Net profit for the quarter was up to £1.51bn, from £1.37bn.
So despite the negative economic environment I’m buying more Barclays shares for 2023. Certainly with interest rates set to go even higher, and due to hedging that should push long-term revenues upwards.
