Financial services industry has a fourth quarter to forget
You don’t even have to open the latest Ernst & Young Financial Services Index to get a feel for sentiment in the banking sector. The cover provides a sombre warning: “Slowing economic fundamentals push confidence levels to record lows!” The Ernst & Young survey “is designed to assist in analysing trends in the banking sector over the short run.” In today’s newsletter we’ll examine some of the survey results for the banking, investment management and life assurance sectors in the fourth quarter of 2008.
The survey confirms a major slide in confidence in the Ernst & Young Banking Index from 61 to 50 points (led by the Investment Banks Index which fell from 81 to 46 points). The life companies were slightly more upbeat – Mzandile Jacks reveals in Business Report that the Ernst & Young Insurance Index climbed marginally from 51 to 53 index points. South Africa’s financial services environment is tiny when compared to other Western economies. Four major banks dominate the retail banking environment with six plying their trade in the merchant and investment banking space. And Old Mutual and Sanlam remain the dominant life assurance plays.
Retail banks see slower growth and rocketing expenses
The problem at retail banks is that their income is drying up. We’ve all had first-hand experience of part of their problem – the huge correction in global equity prices as the world struggles with the ongoing credit crisis. Says Emilio Pera, lead banking director at Ernst & Young: “We have seen a number of changes in the economic climate in the second half of 2008, and it was only a matter of time before this was going to impact on the corporate and investment banking sector. For example, global commodity prices have retreated since reaching a peak in July 2008. The gold price was an average 20% off its peak price, whilst platinum prices were more than 50% lower in the fourth quarter of 2008.” Banks were hit hard as fee-based income and investment income dried up in Q4 last year. And as banks tightened their lending stance to accommodate the global decline in credit supply and liquidity they’ve seen a huge decline in interest income too.
With the income half of the equation in a shambles you’d expect banks to try and cut on the expense side. And that’s where the problem really starts. Although not an expense in the true sense of the word, each of the country’s major retail banks has had to provide for unexpected growth in non-performing loans. You and I refer to this as bad-debt; but banks prefer to use the term “credit impairment” in their annual reports. Ernst & Young summarises the situation, saying “falling income and rising expenditure growth led to contracting net profits!” Other expenses continue higher in line with inflation and it comes as no surprise that the major banks show zero employment growth for the period.
We expect this situation to continue in the first quarter of 2009 and will be watching bank earnings in coming quarters to see just how bad the situation is. Given these lower income expectations we can’t help taking a look at the supposedly low valuations of these companies on the JSE. The price-to-earnings ratios are low for a very good reason – future earnings will disappoint.
Investment banks struggle with shrinking business volumes
One of the major challenges for the country’s investment banks is that mergers, acquisitions and other ‘big money’ transactions grind to a halt during economic downturns. We’ve now had confirmation that the US, most of Europe and Japan are in technical recession, with the US entering this murky territory as early as December 2007. Everyone agrees the market slump will be longer and deeper than previously imagined.
Local investment banks shouldn’t be too surprised that their business volumes are on the decline. Ernst & Young reports that “Private equity and corporate finance contracted the most” with treasury and other specialised finance activities weakening considerably too. Fee income is down in tandem with lower business volumes, while investment income plunged for the same reason as retail banks’ – depressed world markets. According to Pera, “investment banks started tightening credit standards later than their retail peers…” Operating expenses might be slightly down, but “the bottom line was nevertheless adversely affected by income growth falling faster than expenditure growth.”
A slightly better outlook for insurers; but
Although the confidence index showed a small up-tick where life assurance companies are concerned it remains near its lowest level since it started some five years ago. Lead insurance director at Ernst & Young, Tim Rutherford, says that “while the basic operations at the core businesses are in good shape, it is really investment income and earnings which are hurting the life insurance market.” This was something FAnews Online commented on when reporting on Sanlam’s 10-month operating update late last year. Our headline read: “Sanlam earnings down 86% despite satisfactory operating result!” And those earnings were down due to the shocking return on equity markets and a significant reduction in capital due to share buybacks.
Although insurers report consistent growth in new business, Rutherford warns that rising surrenders and lapses remain a real threat. “The ability of new policy holders to pay monthly premiums is what counts, and that is where the industry is feeling the pinch.” Is anyone surprised at the lacklustre market performance from Sanlam and Old right now?
Editor’s thoughts:
As we enter 2009 there’s no sign of an end to the global economic crisis that wreaked havoc on equities last year. Interest rates remain high while consumers are still struggling to recover from long periods of over-indebtedness. Have you noticed an increase in policy surrenders since the middle of 2008? Add your comments below, or send them to gareth@fanews.co.za
