Bank Confidence rises despite continued shrinking profits

A survey released by Ernst & Young today, indicates that banking profits continued to fall in the 3rd quarter of 2009, in line with an economy battling to shrug off recession.
The survey found that banking confidence rose from 39 index points in the 2nd quarter, to its current level of 43.

Once again, the revival of banking sector confidence is solely due to the investment banking sector, where confidence levels rose from 50 to 57. Retail bank confidence, on the other hand, remained virtually unchanged for the third quarter running. Retail bank confidence came in at 29, indicating that whilst confidence levels have probably reached the bottom of the cycle, they are struggling to recover.

This is the 31st quarterly survey conducted to measure confidence in the banking industry, and the research is conducted by the Bureau for Economic Research in Stellenbosch.

Comments Emilio Pera, the lead Banking & Capital Markets director at Ernst & Young, ‘For the second consecutive quarter, we have seen that investment banking confidence has moved considerably higher from its trough, recorded in the first quarter of 2009. The general economic outlook was considerably bleaker for them back then. Global equity markets were trending sharply downwards; commodity prices were moving in tandem; and there was very little available funding for financing projects.’

He continues, ‘This scenario has changed substantially since the first quarter. Equity markets seem to be rising again, and coupled with this, there is talk of an end to the recession in much of the developed world. As a result, world commodity prices have revived, and there has been a gradual improvement in liquidity, resulting in enhanced capital availability to allow for increased project lending.’

‘Nevertheless’, he continues, ‘ profits for both retail and investment banks continue to shrink. Indeed, investment banking profits contracted at a record-high pace during the 3rd quarter, with all survey participants indicating that their bottom-line profits had contracted.’

‘The improvement in confidence thus appears to be linked to forward expectations. Business volumes, although still contracting overall, measured a marked improvement over the previous quarter. With the exception of treasury & specialised finance, all areas of investment banking activity recorded a turn-around from the previous quarter, in line with improving economic prospects.’

In the case of retail banking, there is little sign of a turn-around just yet, although during the recent reporting season, all the major banks indicated that they were seeing an improving trend-line with regards to credit impairments. Says Pera, ‘ Even so, it appears likely that certain product portfolios, particularly home-loans and asset finance will remain unprofitable for the remainder of the year at least.’

In line with their investment banking peers, retail banks also recorded the strongest yet recorded rate of profit contraction in the 3rd quarter. The retail banks’ profitability is largely pressured by declining interest income, as the combination of credit impairments and weak credit extension, continue to squeeze interest margins.

However, says Pera, ‘there appears to be a turnaround in the credit impairment trend, which troughed in the 3rd quarter of 2008, and has been on a subsequent improving trend-line since. Indeed, currently, impairments are growing at only half the rate they were one year ago. This is likely to result in improved bottom-line profitability going forwards, and the banks forecast that to start materialising during the 4th quarter.

Other survey findings include:
* Retail and investment banks continue to shrink the headcount. Indeed, comments Pera, it is well known that most of the banks have a policy in place to not replace departing employees, in an effort to achieve cost reductions.
*  Operating expenses have adjusted downwards, in line with lower revenue trends. In the case of retail banks, cost growth was flat during the 3rd quarter, whilst it was moderately positive in the case of investment banks, and substantially below the historical rate of increase.
*  Credit standards in retail banks, whilst not easing, are definitely not rising at the strong levels recorded since 08Q4.
*  Credit standards in investment banks recorded their first easing, following substantial improvements in credit impairments and credit loss trends.

Concludes Pera, ‘Although banks have made significant strides in cost reduction, to align with a declining revenue environment, they nevertheless continue to experience contracting profits. It is thus not surprising that their confidence levels remain low by historical measures. There appears to be light at the end of the tunnel though, for both retail and investment banks alike. Retail banks have been through the worst in terms of impairment trends, and profits are likely to improve from the fourth quarter onwards. Investment banks have seen the first signs of revived activity levels, and this coupled with greater market liquidity is likely to improve their prospects going forward.’