Government securities saved profits of banks, but not for long

(infographics by Dariusz Gąszczyk)

Generally high profits were due to factors whose influence has already expired or is expiring. Other factors that had negative impact on the results struck simultaneously in the first quarter and will exert their influence in the coming months. The benefits of the strengthening economy will probably be felt by banks only at the end of the year.

„All the challenges revealed themselves in the first quarter. The lower interchange rate, lower interest rates, the higher fee to the Bank Guarantee Fund,” said the CEO of Citi Handlowy, Sławomir Sikora, at the conference summarising the quarterly results of Citi Handlowy.

Despite these challenges, the quarterly net profit of the sector exceeded PLN4 billion and was 1.6% higher than in the corresponding period of 2014 (Q1/Q1). It was also nearly PLN1 billion (32%) better than  Q4’2014. This does not mean that banks have overcome the combination of developments that adversely affected their profitability, but only that they took full advantage of favourable opportunities. Forecasts predicting a double-digit decline in the net profit of the sector still apply.

Let us start with the interchange fee, which a year ago was 1.2% on debit cards and 1.3% on credit cards. In February, it dropped to 0.2% and 0.3% respectively. Nevertheless, the quarterly net result from fees and commissions was only PLN120 million down to the previous year, a drop of less than 3.5%. It is worth noting that in March 2015, the net result from fees and commissions was only PLN2 million lower than in March 2014.

Why did larger declines not occur? There are two reasons. The first is the attempt to increase transaction volumes. „Business volume in 2015 will be the primary objective,” said Sławomir Sikora. „I do not rule out the possibility that some balance sheet items may grow by double-digit figures,” added mBank’s President Cezary Stypułkowski after the announcement of the bank’s quarterly results.

The second one is the introduction of fees and commissions in all possible areas of operation. Banks are imposing or increasing fees for account maintenance, use of debit cards, credit cards, and finally they are even beginning to charge fees for withdrawals from ATMs.

(infographics by Dariusz Gąszczyk)

(infographics by Dariusz Gąszczyk)

The question is whether this strategy can bring the desired results in the long run? Taking into consideration profits from commissions, it seems that for the time being it can. The main reason profit does not deteriorate, however, is because although income from commissions decreased by 5.5% y/y, it was accompanied by a larger 12.3% decline in associated costs. This is probably, among other things, a result of higher volumes of mobile transactions and cuts in any additional bonuses for using credit cards.

Conflicting strategies?

The key issue boils down to the question of whether the strategies involving the maximisation of commissions and increasing fees will be in conflict with efforts to increase volumes.

This can be seen in the case of the credit card market. Although some banks can boast a major increase in the number of cards as well as trade and transactions volumes, throughout the sector data show that an opposite process took place in this segment.

Gross debt from credit cards decreased in Q1’2015 by more than PLN300 million, i.e. by 2.6%. According to NBP data, in Q4’2014 the number of payment cards increased by 560,000, i.e. 1.6%, but this was only an increase of a number of debit cards because the number of credit cards fell slightly. It is possible that in Q1’2015 this trend strengthened.

In addition, aggressive re-pricing can bring only short-term effects because competitors take advantage of imprudent pricing decisions. The previous year has already shown a clear trend among customers to change banks, and although there is no aggregate data on the subject, partial sales data reported by individual institutions suggest that a substantial percentage of consumers are “disloyal”. Customer flows are probably multi-directional and it may happen that a certain bank loses customers to another bank, but at the same time also acquires customers of other banks.

Some banks, however, manage to achieve better results in customers’ acquisition, which can be associated with moderate pricing actions. ING BŚK reports that it gained 120,000 customers in Q1’2015. „The majority of customers acquired by us are those who changed their primary bank,” says Małgorzata Kołakowska, CEO of ING BŚK.

At the same time, some institutions distance themselves from the trend of jacking up product prices. „Price is important, but the most important thing is the quality of people cooperating with customers. We do not need to hide margins,” says Luigi Lovaglio, President of Pekao. „It is possible that we will modify prices a little bit, we will certainly not find ourselves in the group of extreme offers,” adds Małgorzata Kołakowska.

Consumers are not going crazy

Similar doubts apply to the credit market. The deterioration of net interest income means that some banks decided on the strategy of spectacular increases in commissions for granting loans, especially consumer loans. Because the anti-usury act prohibits interest on loans four times higher than the lombard rate, i.e. from March 2015 higher than 10%, banks try to make up for this with commissions. For example, the official table of Credit Agricole reports that the commissions on consumer credit can be up to 25% of its value. Alior Bank, where the commissions reach 30%, leads the ranking of media information.

At the same time, contrary to the aspirations relating to volume growth, lending is growing at a moderate pace. According to aggregate bank plans presented by the Polish Financial Supervision Authority (FSA), institutions are forecasting growth in the gross portfolio of consumer loans by 13.6% this year, i.e. by approx. PLN18 billion, following a very moderate increase of 3.85% last year. However, Q1’2015 does not bode well for this „planned” growth. The value of the portfolio during the three months increased by slightly more than PLN800 million, i.e. 0.6%. Here the question arises, whether the huge credit fees mean that cheap money is not cheap at all, and therefore consumers are taking on debt with moderation.

(infographics by Dariusz Gąszczyk)

The carrying value of loans to enterprises increased in Q1’2015 by PLN7.3 billion, i.e. 2.4%, which is less than in Q1’2014, when the increase was 3.1%. In the SME segment, loans increased by 1.5%, less than in the previous year, when it was 1.8%. In this market at least several large banks are preparing for strong expansion, but a breakthrough cannot be expected earlier than by the end of the year.

(infographics by Dariusz Gąszczyk)

The 2.8% increase in total loans to the entire non-financial sector, and in particular the increase in mortgage loans by nearly PLN14.5 billion, i.e. 4.1%, includes the increase in the exchange rate of the franc.

Downward pressure on margins

The vast majority of banks decided to break up the costs associated with the March fee to the Bank Guarantee Fund – which was almost twice as high as last year – into four quarters. In other words, costs will increase by approx. PLN250 million against the last year’s figure. In Q1’2015 – after deducting the effect of the higher fee paid to the BGF – sector costs were PLN100 million higher than in the previous year. The adjustment on the cost side probably hit a barrier that will not be overcome without decisive cuts.

A large part of the increase in costs is marketing and technology costs. According to market sources, one of the top five banks will spend PLN100 million this year on a new electronic customer service system. Higher costs in these areas may be evidence of intense competition in the fight for increased volumes.

“There will be enormous downward pressure on the net interest margin (NIM) in the interest income. We want to compensate for this with an increase in volumes,” says Mateusz Morawiecki, CEO of BZ WBK. The October reduction of the lombard rate by 100 basis points, while other rates were already cut by 50 bps in Q4’2014, strongly impacted the net interest income. mBank estimates that the „asymmetrical” lombard rate cut has reduced its result in Q1’2015 by PLN40-50 million. The March rate cut could not fully translate into the results of Q1’2015, and its effects will be visible in Q2 and Q3’2015. In Q1’2015, net interest income of the sector decreased by 6.1% year on year. It also fell by almost PLN100 million, i.e. 1.1%, compared to the previous, very weak quarter.

If there are no further reductions in interest rates, a chance to stabilise net interest income will come only in Q4’2015, and a rebound will be possible in 2016. Meanwhile, bankers are far from being convinced that the cycle of interest rate cuts ended in March. „If we look at long-term forward rate agreements, there may be another reduction of 25 basis points,” says Morawiecki. „It is more likely that the Monetary Policy Council will resume the cycle of reductions, than there will be any increases,” adds Ernest Pytlarczyk, chief economist at mBank.

Therefore, only a few banks expect the fall in NIM to stop this year. Pekao expects that its interest margin at the end of 2015 will be 20-30 basis points lower than in December 2014.

(infographics by Dariusz Gąszczyk)

Currencies and bonds saved profits

What, besides increases in fees and commissions, pushed up the results of banks in Q1’2015? It was yet another (the last?) peak of the boom in Treasury securities which ended with a spectacular correction at the turn of April and May and the instability of exchange rates. And so, BZ WBK made PLN188 million in Q1’2015 on government bonds, compared to PLN29 million in Q1’2014. ING BŚK had PLN600 million from the valuation of this portfolio. „Handlowy made good use of the time to sell its portfolio. We did not miss the moment to make a profit,” says Sikora.

The high prices of bonds and profits from foreign exchange transactions caused the „other” item in the results of banks in Q1’2015 to swell to PLN2.2 billion, an increase of 67.1% y/y, and an increase of 71.3% compared with the previous quarter. It was this almost PLN1 billion, by which profit in Q1’2015 was better than in the previous quarter. While the swings in currency markets should still allow banks to make money, this last reduction in the price of bonds may end the possibility of using this booster. This will also result in new challenges when it comes to managing interest rate risk. „Some banks will decide to move their AFS portfolios to the HTM portfolio,” says Sikora.  „It will be a very difficult period for managing the interest rate. I would be close to using the term rollercoaster ride when it comes to fixed rate instruments,” he added.

Sweep francs under the carpet

How, in the light of the impact of these phenomena, can results in the sector shape throughout 2015? In the plans submitted to the FSA, banks predicted a decrease in profits by 10.3%, i.e. to approx. PLN14.5 billion. „The decrease in the results of banks by 10% was a forecast from the first quarter. There is downward pressure acting on this forecast,” says Sławomir Sikora.

The CEO of BZ WBK is convinced that regulatory factors will have a negative impact on the income statement of the bank by an amount exceeding PLN500 million. The exceptionally good results of the first quarter were also influenced by PLN423 million net which BZ WBK got from the sale of insurance company Aviva. If the „other” results of banks return to normal, then – given the March rate cut – the net profit of the sector both in Q2 and Q3’2015 should not exceed PLN3 billion. Therefore, the annual result depends on the scale of rebound at the end of the year. And it depends, in turn, on the strength of the economy. Optimism prevails in this regard, and growth forecasts are being revised upwards.

„GDP in the coming quarters may grow by nearly 4%, and for the whole year it could be more than 4%,” says Zbigniew Jagiełło, CEO of PKO BP. None of these forecasts take into account perhaps the most important factor – the issue of solving the problem of mortgages denominated in Swiss francs. The zloty has strengthened against the franc, and bankers say that they do not see problems with instalment payments.

„There are no warning signals when it comes to the portfolio of mortgages in CHF,” says Piotr Mazur, Deputy CEO of PKO BP and Chief Risk Officer. Direct or side effects of mortgages in CHF are already translating into the results and operations of banks. Firstly, temporary solutions to reduce the burden on customers, such as narrowing foreign exchange spreads, restrict profits in an obvious way. „A permanent spread reduction means PLN14 million a year for the bank,” says Joerg Hessenmueller, Deputy CEO of mBank.

Secondly, the appreciation of the Swiss currency led to an increase in the carrying value of loans, and therefore, their loan-to-deposit ratio (LTD). The LTD ratio in the entire sector increased from 100.1% at the end of last year to 107.2% at the end of Q1’2015. This limits lending for some banks, especially in the mortgage segment.

The statements of the representatives of the banks indicate that they would already gladly consider the problem of loans in francs as no longer relevant. But not everyone is convinced that the CHF’s issue should be swept under the carpet. „The risk will loom over the entire sector (…) The banking sector in Hungary suffered large losses because it did not find a good solution sooner. In the first year, the losses would have amounted to 10%, but then their scale grew. We’d better draw conclusions from this,” says Sławomir Sikora.

(infographics by Dariusz Gąszczyk)

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