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Renewed investor uncertainty keeps banking confidence weak

14 July 2010 Ernst & Young Financial Services Index

A survey released by Ernst & Young today indicates that although banking profits are slowly recovering from levels seen during the 2008 liquidity crisis (with both retail banks and investment banks growing interest and non-interest revenue), overall confidence levels remain weak. The survey found that banking confidence fell from 45 index points in the 1st quarter of 2010, to 33 currently.

This is the 34th quarterly survey conducted to measure confidence in the banking industry, and the current confidence levels are the lowest since inception. This research is conducted by the Bureau for Economic Research in Stellenbosch.

Comments Emilio Pera, lead Banking & Capital Markets Director at Ernst & Young, ‘ Retail and investment banking confidence levels moved in opposite directions during the second quarter. Retail banks continued a slow recovery from a very tough 2009. Investment banks, on the other hand, reached their lowest ever confidence reading in the close on nine year history of the index.’

He adds, ‘ The 2nd quarter of 2010 was a tough one for the financial services sector, across the globe. Renewed investor uncertainty was caused by fears of a Euro debt crisis, on the back of national debt default concerns. This originated in Greece, but fears of contagion soon led to finger pointing at other countries considered to be highly indebted. As a result, the Euro lost considerable value through the 2nd quarter, although the currency seems to have stabilised in recent times.

In this environment, with investors still reeling from the impact of the 2008 liquidity crisis, they quickly retreated from bond and equity market holdings. As a result, global liquidity once again became a concern for investment banks. In such an environment, investment banking revenues are typically strained.

The survey found that business volumes at investment banks remained weak in the 2nd quarter. Whilst demand for corporate finance and stock-broking services is growing, other areas of activity continue to contract, off already weak levels. Says Pera, ‘Even treasury activity failed to grow in this volatile period, a time when activity levels usually peak. However, local banks are not out of sync with global trends. A recent global survey conducted by Ernst & Young found that 54% of bank CFO’s cite a challenging economic environment as their major concern.’

‘In addition’, he says, corporate demand for credit remains weak. This is borne out by the most recently available corporate sector credit extension statistics, which year-on-year to May, fell 1.5%. However, this is an improvement on the April y-o-y reading of -5.1%

As a result of weak credit demand, coupled with flat activity levels, investment banking income growth remained weak in the 2nd quarter, albeit ahead of first quarter levels.
‘In fact’, says Pera, ‘income levels are starting to grow positively for the first time since late 2008 – albeit only marginally. This indicates that despite the continued subdued confidence, slowly recovering income levels are resulting in a gradual turnaround in key financial measures at investment banks.’

With regards retail banks, income levels also returned to positive territory after a weak 2009. Similar to the investment banking experience, demand for credit across households is weak, although beginning to grow positively again. In the month to May, household credit growth y-o-y rose 3.8%.

Comments Pera, ‘The slow rise in consumer credit demand is resulting in a gradual improvement in retail banks’ income levels, which in turn is improving their net profits. Even so, profits continue to contract, and have been doing so for two consecutive years.’

He adds,’ Not even sharply contracting credit losses have allowed profits to start growing positively yet. Despite the falling credit loss position, retail bank expenses rose sharply in the 2nd quarter, fuelled by rising marketing and systems costs.

‘Growing regulatory demands require on-going expenditure on systems upgrades to meet the increasing requirements of compliance. Although banks were able to slow their expenses growth through 2009 in line with contracting revenue flows, a pent-up demand for IT projects has developed, and banks simply cannot delay certain key expenditures any longer. In addition, our global CFO survey indicates that skills shortages remains a concern for the industry, and this too impacts on costs, as banks have to compete for a limited skills base.’

The strong cost growth offset the moderate income gains, resulting in sustained retail banking profit losses in the second quarter, albeit at improved levels.

Concludes Pera, ‘ Both investment and retail banks are likely to see an improving profit scenario through the remainder of 2010, barring further global investment uncertainty. This will be led by rising credit demand, and a continued improvement in the credit loss environment, which collectively will allow both investment and retail banks to report a return to profits growth. At the moment, banking confidence remains considerably below its long-term average level of 79, and hit its weakest reading yet recorded, however indications are that fundamentals are likely to improve from here.’

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