Banks still confident in spite of stressed consumers

Bank profits growth remains resilient– growing in both the investment banking and retail banking sectors in Q407, according to the latest quarterly Ernst & Young bank index findings measured in December 2007. In turn, this has held bank confidence steady, at 98 index points, down slightly from the maximum 100 point level.

Says Emilio Pera, lead Banking Director at Ernst & Young, ‘Despite all the signs of distressed consumers, including household debt ratios reaching 77.5% of disposable income in the third quarter of 2007, bank profits growth remain strong. With resilient profits, it is perhaps understandable that nearly all retail banks remain satisfied with current trading conditions. ‘

Although banking profits saw an upsurge in the last quarter of 2007, consumer debt service costs rose from 9.6% to 10.3% between the 2nd and 3rd quarters of 2007. Furthermore, this is likely to have risen again in the 4th quarter, given the additional two 50 basis point interest rate hikes that were announced during the quarter.

Says Pera,’It appears thus far, stronger interest margins have offset lower credit demand, therefore holding bank profits growth at high levels. A rising interest rate environment usually serves to boost bank margins, particularly in the short to medium term, before bad debt levels start to pinch.

Despite a slowing consumer market cycle, which is reflected in a lower demand for loans, the retail banks have yet to feel the pinch, due to their stronger margins.’ 


Continues Pera; ‘Further into the trough of the cycle, we expect that non-performing loans will offset the stronger margins, thereby impacting bank profits. Moody’s warned in late December (Moneyweb 21/12) that they expect banking profits to fall in 2008, due to consumer indebtedness making mortgage payments more difficult to meet. Moody’s estimates that mortgage lending makes up just on 40% of total lending, and that is the lending category most likely to feel the crunch of squeezed consumer disposable income.’

Investment banks, by contrast, are seeing higher demand for credit, as infrastructure spending by government and private – public partnerships start to take off. This has kept interest revenue growing at a brisk, constant pace, despite more intense competition than their retail peers face. Not only the local banks, but also the foreign banks play a strong role in this market. ‘In that sense’, says Emilio Pera, ‘corporate and investment banking is more competitive than the retail market, which is essentially dominated by the Big 4 banks.’

Investment banks’ key income driver – fee income growth– continues to remain steady, although not at the same higher levels experienced through 2006.

Other findings include continued strong cost growth – in both retail and investment banks. This is particularly of concern in the light of slowing revenue growth for the past few quarters. Says Emilio Pera; ‘This is one major area of concern for the banking industry. Banks have had a number of ‘unavoidable’ costs they have had to incur in the past few years, mostly due to regulatory and compliance requirements. Until now, strong revenue growth has supported a lot of these additional required costs. With Basel II becoming effective on January 1 2008, the banks continue experiencing major expense items that they have no choice but to incur.’

Whilst the structure of South African banks is such that all of the major local banks have exposure to both corporate and retail markets, there is no doubt that slowing retail revenues will leave less room for sustained cost growth into 2008.

Pera also points out that banks are not alone in the financial services industry with regards to spiralling costs. All sectors of the industry, including life insurers and investment managers, have faced strong cost pressures over the past few years, also related to growing compliance and regulatory requirements. The life insurers and investment managers both showed signs of slowing expenditure in the fourth quarter of 2007, unlike the banks, whose expenditure growth continues to remain high.

Even so, with the exception of small investment managers, whose confidence fell for the second consecutive quarter, the other financial services segments all remain very close or at full confidence levels.

Concludes Pera, ‘Thus far, the banking sector has shrugged off the impact of slowing retail demand. For the local banks, their investment banking operations are offsetting some of the impact of the slowing retail segment. But it appears the real impact is only likely to hit in 2008, and the signs indicate that confidence is likely to further recede in the retail banking industry, although investment banking prospects remain strong.’