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Why I’d buy Barclays plc over this challenger bank

A 33% increase in underlying pre-tax profits was not enough to satisfy investors in challenger bank CYBG (LSE: CYBG), with shares in the owner of Clydesdale and Yorkshire Bank dropping by as much as 3% today.

Upbeat set of results

CYBG’s profit growth was driven by an increase in mortgage and SME lending, as well an improvement on costs — the bank’s underlying cost to income ratio fell from 74% last year to a more respectable figure of 67%. Additionally, actions to reduce its cost of funding paid off, as net interest margins widened by 1 basis point to 2.27% in contrast to many of its rivals.

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Nevertheless, warnings about increased competition in mortgage lending weighed heavily on its shares. The bank has only become the latest in the sector to warn about the impact of competitive market conditions, after Virgin Money last week said it expects net interest margins to decline to between 1.65% and 1.7% next year because of falling rates on new mortgages.

Inaugural dividend

However, it’s not all doom and gloom for investors as the bank proposed its first dividend since its listing in 2016. The bank recommended an inaugural dividend of 1p per share which, more than anything, is seen as a symbolic move and a vote of confidence from management in the bank’s future prospects.

We have delivered a strong performance in 2017 having met all of our targets and recorded our first statutory profit in over five years,” commented chief executive David Duffy.

A better buy

CYBG is making good progress with its restructuring efforts, but it’s not the only bank with attractive turnaround prospects. With a price-to-tangible book value of just 0.67, I reckon Barclays (LSE: BARC) could be an even better buy.

Sure, it’s clear that Barclays doesn’t have everything going for it — the bank only recently reported painful Q3 figures, which showed another increase in PPI provisions and a drop in revenue from its UK operations. But low investor confidence and recent weak results could translate into a great contrarian opportunity.

Profits and margins aren’t nearly as crimped as they had been in the immediate aftermath of the financial crisis. And on the flip side, the bank has more room to improve returns.

Although the bank continues to face challenges caused by legacy issues, there are growing expectations that a resolution of these issues will come soon and eventually lead to a recovery in profits.

Valuations

Moreover, valuations for the Footsie giant are tempting, with shares in Barclays trading at just 11.6 times expected earnings this year. What’s more, underlying earnings is expected to rise by a further 28% next year, meaning its forward P/E on its 2018 earnings would fall to only 9.1 times.

This compares favourably to CYBG, which trades at 13.8 times its 2018 earnings, and has a price-to-tangible book value of 1.02 times.

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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