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Why I’d dump dividend dud Barclays for this high-yield lender

A decade from the onset of the financial crisis and Barclays (LSE: BARC) is still far from the high-dividend dynamo it used to be. But CEO Jes Staley is finally making some headway with the group closing its non-core operations, its highly adjusted Q1 return on tangible equity (RoTE) crossing the psychologically important 10% level, and dividends payments slightly increasing.

However, this doesn’t make me more interested in buying Barclays’ shares for their income. For one, the forward dividend yield based on a forecast full-year 2018 payout of 6.5p per share is only 3.4%. This isn’t terrible but it still lags well behind the one on offer from rivals such as Lloyds and, in my opinion, doesn’t adequately compensate for the greater risks one takes investing in this highly cyclical industry.

Second, there are still company-specific risks with Barclays that give me pause. Foremost are continuing litigation and conduct charges that totalled £2bn in Q1 alone, and high operating expenses that eat up a whopping 63% of all operating income. Indeed, including the effects of these litigation and misconduct charges led to statutory RoTE falling to -6.5% in Q1. Given the various regulatory bodies still pushing forward with investigations, I wouldn’t be surprised if there are further big charges in the future.

And while the bank’s massive investment arm finally turned a solid profit in Q1 with RoTE of 13%, one good quarter has not convinced me that this division can finally earn returns on a long-term basis.

While Barclays is going in the right direction, there are still enough red flags to leave me wary, and adding in a relatively low yield and uncertain economic environment makes me quite happy to not be a shareholder.

A lender consistently posting impressive returns 

I’m much more interested in sub-prime doorstep lender Morses Club (LSE: MCL), which offers investors a hefty 4.19% dividend yield. While the phrase ‘sub-prime lender’ will scare many investors, Morses Club is in quite good shape.

Unlike big banks such as Barclays that were brought to their knees in 2007 (in part thanks to very high exposure to sub-prime mortgages), Morses Club has a long history of lending profitably to non-prime borrowers. It actually knows what its exposure to these loans is, it is well capitalised to survive any downturns, and is very picky about its customers with a full 70% of loan applications rejected.

And despite this rather cautious approach to adding customers, its loan book is growing rapidly thanks to the self-inflicted woes of sub-prime giant Provident Financial, which changed its business model last year and sent many of its self-employed agents into the arms of Morses Club.

The full effect of these new agents will take a few quarters to flow through, but in the year to February, the group’s customer numbers bumped up 6%. And a strong focus on lending to its highest-quality customers saw total credit issued rising 21% and underlying pre-tax profits jumping 29%.

Looking ahead, I see plenty of reason for growth to continue at this pace as the company has secured additional capital from lenders, is branching out into offering related services and should be taking market share from wounded Provident. This growth, alongside a high dividend, makes me much more interested in Morses Club than Barclays.

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays and Lloyds Banking Group. 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.