Banks slowing down?

The net profit of banks after nine months of the year exceeded PLN 11 billion, according to the Polish Financial Supervision Authority (KNF). It is PLN 100 million less than the result after three quarters of the record year 2011.

Does this mean that the banking sector analysts who repeatedly use the word “good” are wrong? No, it does not, since this year’s result was generated in different macroeconomic conditions. The economic growth rate was at least 4% in all quarters of the previous year, while this year the GDP growth rate has gradually declined from 3% in the first quarter, 2.4% in the second quarter to less than 2% in the third quarter, as argued by the authors of the November inflation projection of the National Bank of Poland. For the growing economic slowdown, the result lower by only PLN 100 million is surprisingly good.

“If we look at the listed banks, the key to success in the third quarter lay in profits on bonds,” says Michał Sobolewski, a banking sector analyst at DM IDM.

Such profits may occur when the demand for bonds appears suddenly on the market due to expected imminent interest rates cuts.

This factor was recorded in virtually all banks, though it had a varied impact on their results, due to i.a. differences in the balance sheet structure. Bank Handlowy had proportionally one of the largest positions, which was also actively managed. Therefore, before the publication of quarterly reports the bank was considered by the analysts as the frontrunner, which position it later reaffirmed with a significant improvement of results on an annual basis. Another distinctive feature of the bank compared to the sector is the lower share of loans in the balance sheet, which proved to be an advantage this quarter due to a relatively widespread increase of the costs of risk or creation of provisions in the sector.

Also in the case of Pekao, the sale of bond portfolio was one of the reasons for the net profit being higher than projected. Although in this bank such operations usually generate PLN 40 million, the figure amounted to PLN 156 million in the last record quarter. The items that determine repeatability of quarterly results, such as the interest income, commission income or the level of reserves, were slightly less spectacular. One more aspect that needs to be taken into account is the delayed business cycle.

“In no way diminishing the management skills of the boards of our banks, we should not forget that the sector reacts with a certain delay to the changes in the economic situation,” points out Iza Rokicka, an equity market analyst at Dom Inwestycyjny BRE Banku.

Persons who lose their jobs often receive a severance pay which allows them to cover their liabilities for the next several months. If they do not find a new source of income, their financial standing begins to deteriorate. This may result in problems with timely repayment of loans and thus in the pressure on increasing the NPLs which deteriorate the financial result of the sector. However, before such scenario materializes, a different phenomenon usually appears. When the bank customers start to be concerned about their future income, they limit their appetite for financial products. The phenomenon is well visible when the results are compared on a quarterly basis.

Another trend has also appeared. In the first half of the year, some banks tried to increase the sales of cash loans to compensate for worse results of the sales of mortgage loans. The lower quality of this new portfolio has met with a slight disappointment by the management boards of the banks. The adjustment usually consisted in abandoning the policy of granting small loans and pursuing the policy of offering large loans to customers with very good financial credibility. This entails, however, a lower profitability of the banks.

It is no wonder then that the pressure on margins is increasing.

The banking sector analysts agree that at least from the second quarter the interest income, which is the main item generating the net profit, has been „turning aside”.

“In some banks the corresponding revenues in the previous quarter declined, despite unchanged or even increased loan volumes,” says Tomasz Bursa from IPOPEMA Securities.

Encountering the demand barrier in the retail segment, some banks decided to intensify their activity in the corporate segment, where margins are lower than in the retail segment.

This is not the only problem highlighted in the financial statements, but its full presentation requires taking a look at the next year.

The overwhelming majority of the sector analysts agree without any doubt that the result for 2013 will be worse than in 2012. This is due to several reasons, some of them being regulatory. They include:

the expected drop in revenues due to the reduction of interchange fees;

the expected increase in payments for the Bank Guarantee Fund as a result of the introduction of the so-called prudence fee;

the continuation of interest rates cuts;

further deterioration of the GDP growth rate and thus of the loan portfolio, and an increase in the cost of risk.

According to Tomasz Bursa, only the two first factors may result in the net profit of the sector next year being 10% lower than the current profit. With two more factors added, the result of the sector may be lower by almost 20%. The loss is too big to be compensated otherwise by the banks.

In at least some institutions, there is a trend consisting in such management of the financial result which would allow to avoid a significant profit decrease next year, compared to this year’s results. This approach is pursued by means of creating reserves.

It may seem that in the third quarter some banks decided to create larger reserves than justified by the current situation of borrowers. It is worth noting that, contrary to the second quarter, this item of the income statement began to grow significantly last quarter, in particular in the case of corporate portfolio, despite the lack of new information about increasing financial problems or bankruptcies of companies. There is a certain correlation between macroeconomic forecasts of the banks and their reserves policy. Some of them allow for the possibility of technical recession in the first half of 2013.

Therefore, the current approach to the creation of reserves should not come as a surprise and this item should increase further in the subsequent quarters. Equipped with experience from 2009, the banks try to avoid creating reserves when their revenues are falling and the situation of borrowers is deteriorating. This time the banks, or at least some of them, try to act in advance. If anything is to suffer, it will probably be the statistics of the sector, since if not for those “additional” or “in advance” reserves, the annual profit could break the record once again.

The approach to the reserve creation policy is not the only common element for the majority of the listed banks. Unlike in previous years, the boards of the banks are not willing to discuss the dividend payout for shareholders. Upon presentation of the quarterly results, some of the boards stated laconically that the situation of their banks allowed to pay out the dividend, but it was too early to consider this in a situation of high uncertainty.

The president of Bank Millennium Bogusław Kott admitted that there was a strong tendency among foreign owners to reduce financing , which of course raises a question how to replace those funds. The answer has been sought for a long time, in particular among the banks with unbalanced deposits to loans relations. This is probably also the reason for an increasing competition for deposits within the sector, in particular since the weakening GDP growth rate induces enterprises to withdraw financial surpluses held on accounts and use them for their own needs.

In addition, the importance of long-term financing is growing due to the expected regulatory changes next year. The data of the Polish Financial Supervision Authority on the share of the five largest banks in deposits and assets paint an interesting picture here.

If we compare the data from September this year and from December 2009, the share of the top five banks shrank by almost 10 percentage points in deposits (to 45%), whereas their share in assets slightly increased to almost 46%.

“Since 2009, the prevailing trend in the sector has been to maintain the cost growth rate in line with the inflation rate. It was despite the fact that the VAT rates have increased since that time, which severely affected the banks, as they cannot shift this charge on the customers, and the fact that the contributions to the Bank Guarantee Fund have doubled,” points out Michał Sobolewski.

It is, therefore, not surprising that the cost/income ratio is the indicator that the boards of the largest banks most often boast about during the presentation of their quarterly results. In their case, economies of scale, which reduce unit costs, are an additional advantage. Smaller banks, in particular those that have not acquired an adequate share in the retail market or gave up e.g. granting mortgage loans in foreign currencies, continue their policy of employment reduction.

Bank Handlowy was one of the first to reduce its personnel at the beginning of the year and saw the positive effects of this measure already in its results for the third quarter. Other entities will most probably do so next year.

“Faced with the economic slowdown and adverse regulatory changes, the banks have very little room for manoeuvre to improve their profitability. I see two possible solutions. The first is to control the costs and the second to increase fees and commissions for individual groups of customers or for specific products,” says Iza Rokicka.

The banks appear to be looking for savings in their operating or marketing costs. However, they seem not very determined to improve their commission income, which may, however,  change diametrically, if the bank tax comes into effect.

Most of the banks were spared the dilemma by a poor condition of the mass customer segment. It allowed them to reduce expenditure for marketing and keep a tight rein on costs.

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