1st Quarter bank confidence declines in line with slowing fundamentals
Ernst & Young Financial Services Index Q1 2009
The latest Ernst & Young Bank index, released today, illustrates that the contracting economy continues to hurt the banking sector. Both retail and investment banks felt slowing economic fundamentals through 2008, particularly in the latter half. As a result, confidence in the banking sector fell to its all-time lowest point, with profits contracting across both segments of the banking market.
The first quarter 2009 index results show that banking confidence fell yet again, from 50 points in the last quarter of 2008 to 36 points in Q109. Retail banks are a little less optimistic about business prospects than what their investment peers are, but both segments nevertheless reflect their lowest confidence levels since the inception of the survey in 2002. This is reflective of continued subdued consumer income, rising corporate distress in some key sectors, and continued fallout from the global liquidity crisis.
Says Emilio Pera, lead banking director at Ernst & Young; ‘ The latest confidence readings in the sector are symptomatic of worsening economic conditions in many sectors of the economy. The recent reporting season from the banks indicates that times are indeed tough, across both the retail and investment banking segments. Most retail banks reported contracting profits growth for the period to December 2008, although most investment banks still reported positive bottom line earnings.
However, continues Pera, ‘ the situation is not an improving one. The index results indicate that in the first quarter of 2009, retail banks and investment banks reported negative profits growth.
The recent financial reporting season also highlights that there are a number of product portfolios which are under strain. Specifically, mortgage backed lending, instalment finance and credit card debt are either unprofitable or marginally profitable for the retail banks at this point. Says Pera, ‘ Both secured and unsecured lending is feeling the pinch of the current GDP contraction. Both have been ascribed to excessive growth extended during the good years of 2006 and 2007.
Adds Pera; ‘ The banks are facing the consequences of rising non-performing loans, and that in turn, is hitting bottom-line profits directly. It is thus not surprising that three of the big four banks reported lower retail bank profits in the period to December 2008.
The investment banking sector, by contrast, saw one bank report considerably lower profits, one reporting flat earnings, whilst two of the four banks continued to see profits growth in the 2nd half of 2008. Says Pera again, ‘ the corporate segment of the banking market has yet to feel the impact of non-performing loans to the same extent that the retail segment already has.
However, it is likely that through 2009, investment banks will also report rising bad debts, despite rising interest rates. In turn, investment banking profits will come under strain, as anticipated in the survey’s findings. This is directly as a result of the global liquidity crunch, which has seen resource demand fall off, and our export focused sectors feeling the pinch of substantially lower demand.’
Continues Pera; ‘Banks are particularly concerned about companies in the key sectors most vulnerable to shrinking export demand, such as mining and manufacturing. Provisions for bad debts are likely to be a major contributor to declining earnings in the quarters ahead, just as it has been for the retail market over the last 18 months.’
Other survey findings include:
· Contracting banking profits, across both the retail and investment banking segments;
· Expenses growth significantly outpacing revenue growth in the retail banking market;
· Contracting employment opportunities in the retail banking sector, and sharply slower employment growth in the investment banking sector;
· Slowing interest and fee income in both banking segments leading to significantly slower income growth;
· All time highs in credit standards tightening, and continuing strong non-performing loan levels.
Comments Pera; ‘ On the plus side, the banks commented at their recent results announcements that they may have reached the peak in retail bad debt levels. Although it is early days yet, the signs are that bad debt levels have probably been through the worst, and are on an improving trend line. The recent series of interest rate relief is likely to further aid the banks, as their clients in turn, feel the effect of that relief. The only uncertainty is the level of unemployment, as key sectors feel the pinch and cut back on employee numbers. Already, employment has been cut in the mining and manufacturing sectors, and should this continue, it may well offset any relief provided by the recent interest rate cuts.’
He adds; ‘There are already two banks that reported absolute profit contractions in 2008, and with investment banking profits also likely to fall, the large South African banks could find themselves squeezed in both the retail and corporate segments in the next few quarters.’
In conclusion, says Pera; ‘The banking sector is itself a barometer of underlying economic fundamentals. The liquidity crunch, whilst not directly hurting the local banking market, has nevertheless made itself felt. With global economic activity contracting, and demand for goods and services under strain, the South African economy in turn will feel the pinch. Expectations of GDP growth are being scaled downwards continually, and although the country has yet to be officially declared in recession, the prospects of strong GDP growth remain unlikely. While the country will be cushioned to some extent by infrastructure spending needs, overall economic growth will be considerably lower than recent years. In this environment, the banks can only manage their lending portfolios carefully, and all indications are that they are doing exactly that.’
