OREANDA-NEWS. Barclays (A/Stable/a) reported GBP1.3bn pre-tax profit (excluding Africa) for 2Q16, including gains on the disposal of a share in Visa Europe and own credit gains, says Fitch Ratings. Excluding these, operating profitability was a modest GBP363m, resulting from lower revenues and mounting losses at its non-core unit (Barclays Non Core, BNC). The group navigated the volatility around the Brexit vote fairly well, benefiting from increased trading activity in foreign exchange and the weakened GBP on the group's USD-denominated revenues.

The group's core business continued to experience pressure on revenues from lower interchange fees on cards due to the regulatory cap and compressed mortgage margins in its UK division, counterbalanced by increased volumes in US cards and low impairment charges. In the Corporate and Investment Bank (CIB) revenues were modest, despite benefiting from increased client activity across rates, foreign exchange and credit, and costs were burdened by structural reform implementation.

Barclays reports its divisional results according to its future expected ring-fencing structure. Barclays UK, the division containing businesses set to be transferred to the regulatory ring fence, continued to see the benefit of past cost-cutting programmes. This division is likely to be more exposed to a deterioration of the operating environment following the outcome of the EU referendum, but we believe that the impact will be mitigated by Barclays' contained risk appetite and diversification. Fitch believes that UK banks will likely face a slowdown in business volumes and higher loan-impairment charges (LICs) as growth in the economy slows down, with possible pressure from rising unemployment and asset value falls on LICs. Furthermore, there could be additional margin pressure in the context of "lower for longer" base rates.

LICs rose slightly in 2Q16 but remain at historically low levels. Retail mortgages show very low arrears and have low average LTVs (47%). While the bank is highly exposed to consumer loans through its UK card business, risk-adjusted returns in this business are very high. LICs in Barclaycard increased in 2Q16 due to a model update but have been well contained to date, benefiting from the benign UK operating environment. Despite the strong performance, this division's profits were eroded by a GBP400m further provision for customer redress (PPI) in the quarter, which reduced its pre-tax profits by more than half.

Barclays Corporate and Investment Bank (CIB), one of the businesses which will remain outside the ring fence, saw a decline of 19% in its profit before tax yoy because of declining revenues and higher structural reform related costs, despite a favourable net impact of foreign exchange movements. Trading revenues benefited from increased client activity across rates, foreign exchange and credit, but this was more than offset by a 31% decline in equity trading revenues, driven by weak market performance and planned business closures in Asia and Europe. Advisory and debt underwriting fees compared well with European peers, but corporate lending and transaction banking income were subdued. We believe that the division may see some structural change as a result of the forthcoming negotiations surrounding Brexit, as operations will be subject to the outcome of agreements reached on "passporting".

Earnings in Barclays' international consumer, cards and payments businesses benefited from strong growth particularly in US Cards and Barclaycard Germany, helped by US dollar and euro appreciation against sterling. Impairments also increased, reflecting business growth and these businesses' riskier lending, but risk adjusted returns remain high.

BNC generated a GBP1.4bn loss, which included the GBP372m impairment on the French retail businesses, which Barclays is in the process of selling and a GBP182m loss on restructuring the LOBO portfolio, so the group can account for it at amortised cost. The portfolio includes long-dated loans with high credit quality to public sector entities, which before restructuring experienced fair value sensitivity to gilt swap spread movements. Barclays' management agreed with the market expectation that BNC will generate around GBP2.6bn losses in 2016, but the earnings drag should ease considerably in 2017, for which they issued a guidance of losses of GBP400-500m, excluding notable items. We expect the run-down of the unit to be achieved in a manner that is accretive to capitalisation.

Barclays' regulatory CET1 ratio improved to 11.6% in 2Q16, while the leverage ratio decreased modestly to 4.2% reflecting increased cash holdings around the UK referendum, and foreign exchange movements. We understand that the group's CET1 ratio is broadly hedged against movements in EUR and USD, while the protection on the leverage ratio is less efficient. Capitalisation is set to improve by over 100bp relative to risk-weighted assets once regulatory deconsolidation of the African businesses and the planned run-down of BNC are achieved.

However, the bank is still working through legacy misconduct investigations, including into pre-financial crisis RMBS-related misconduct, which judging by the outcome for some of its global peers, could result in large fines that will impact its capitalisation once resolved.

The group targets a 100-150bp buffer over the regulatory minimum, which after the reduction of the countercyclical buffer requirement by the Bank of England in June, and with current Pillar 1, Pillar 2a and fully loaded buffer requirements, results in a target of above 12.2%.

The recent results of the EBA stress on its capitalisation (CET1 in the adverse scenario reduces to 7.3%) show that the bank is somewhat vulnerable to increased impairment charges, conduct costs and trading losses, but the simulated impact is well within our assessment of the bank's capitalisation. In addition, we understand that due to the stress test's static balance sheet assumption planned asset and business disposals not completed by end-2015 - such as components of BNC, the African businesses - were not taken into consideration.

The group's liquidity situation is solid, with LCR at 124% and the GBP149bn liquidity pool, of which around half in cash and central bank deposits, covering double the amount of maturing wholesale funding over the next year. The group is preparing for TLAC/MREL requirements by increasingly issuing subordinated and senior debt from the holding company, Barclays plc. The bank's US intermediate holding company became operational in July 2016, and its first financial filings are expected in 4Q16.