Easing credit impairments lifts banking confidence

A survey released by Ernst & Young today indicates that although banking profits continued to fall in the first quarter of 2010, they have recovered considerably from their low levels of 2009. As a result, the survey found that banking confidence improved somewhat, from 34 index points in the 4^th quarter, to 45 currently.

This is the 33^rd 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, lead Banking & Capital Markets Director at Ernst & Young, ‘ Banks have undoubtedly recovered from the global liquidity crisis. Although their profits continue to shrink, there is nevertheless a turnaround in their financial fundamentals. In addition, the rate of profit contraction has abated, particularly for investment banks.’
Firstly, trends in credit losses and credit impairments have gradually improved, after peaking in the 2^nd quarter of 2009. Both retail and investment banks are experiencing lower levels of impairments on their balance sheets, and this follows through to the income statement.

Continues Pera, ‘ During the recent banking results reporting season, individual banks mostly spoke of a year of two halves – where essentially the first half was characterised by shrinking credit demand and rising impairments. This changed considerably in the second half, with impairment losses starting to recede from peak levels, thereby generating relief to operating cost growth. ‘

Overall, the slower impairment ratios are supporting easier credit standards. Retail banks particularly have eased their credit lending criteria, supported by lower interest rates and slowly improving household indebtedness levels.

Secondly, both interest and non-interest revenue is gradually recovering from a very weak 2009. Investment banks experienced were particularly challenged in the fourth quarter of 2009 with interest and non-interest revenue shrinking.

Comments Pera, ‘The global liquidity crisis resulted in sharply reduced capital availability across global financial markets. As a result, there was substantially slower activity across most areas of investment banking. All of private equity; corporate finance; project finance, and specialised finance experienced considerably slower volumes through 2009, and into the first quarter of this year.

Retail banks, on the other hand, experienced sharply reduced fee income growth only in the last quarter of 2009, although it subsequently recovered in the first quarter of 2010. Pera comments; ‘To a large extent retail banks relied on price adjustments to offset weaker volumes of transactions and declining fees stemming from lower levels of new credit agreements. This kept fee income relatively strong through most of 2009, but by the fourth quarter, non-interest revenue growth was feeling the strain of indebted households.’

Retail banks expectations of a turnaround in the 2^nd quarter of 2010 are supported by the recently released Consumer Confidence surveys, which indicates rising consumer confidence. In addition, retail sales trends continue to improve, albeit still negative, down 1.7% year-on-year in January, from -6.6% in November 2009.

Other survey findings include:
- Retail banks continue to shed jobs, as they right-size their organisations in an era of slower credit demand.
- Investment banks, by contrast, continued hiring through the 2^nd half of 2009, despite lower business volumes and weaker profits.
- Banks confidence levels remain significantly below the long-term average level of 80 index points.
- Investment income is slowly recovering from a weak 2009, and is expected to return to positive territory for both retail and investment banks in 2Q10.

Concludes Pera, ‘Expectations are that income levels will recover sharply in the 2^nd quarter of 2010. Both retail and investment banks expect rising credit demand to feed into positive net interest income growth, a situation they have not experienced since the 2^nd half of 2008. This in turn, is likely to lead to a gradual revival in profits growth, with investment banking profits starting to rise again, whilst the rate of retail banking profit contraction improves. Failing another globally influenced crisis, banks are poised to benefit from a lower interest rate environment, which will further stimulate a turnaround in credit demand. The local banks have sufficient capital reserves to favourably respond to growing credit needs, given their improving impairment ratios, and profit prospects.’