The two-year-long run of strong growth in financial services went into reverse over the past three months, as business volumes in the sector fell at their fastest rate since March 1991, a new survey said today (Monday).
The latest Financial Services Survey from the CBI and PricewaterhouseCoopers LLP shows that, as the credit squeeze continued, income values fell sharply and business sentiment worsened, while costs continued to rise.
Yet despite all this, several sectors of the industry managed to increase their profitability over the past three months, and are still hiring staff and planning to invest more, particularly in IT.
Business volumes shrank heavily in the three months to early December: 10% of respondents said that volumes had grown, while 44% said they had decreased. The net balance after rounding of -33% is the lowest since March 1991 (-44%) and markedly worse than expected (-11%). Firms expect this slide to continue in the coming three months, though at a slower rate.
A drop in business with private individuals and financial institutions was behind much of the slowdown in business volumes, though demand from individual consumers is expected to stabilise over the coming three months. Lending to companies held up rather better, and is expected to pick up again over the next three months.
A balance of 11 per cent of firms reported a drop in income from fees, commissions and premiums, which was broadly as expected, but income from net interest, investment and trading fell at the fastest rate since the survey began in 1989 (a balance of -36%). Both are expected to fall further in the next three months.
Despite this, firms reported a surprise fourth consecutive quarter of growth in profitability (a balance of +6%, slower than last survey's +14% but better than the predicted -14%), although this is not expected to continue into early 2008.
Behind the aggregate picture there were big differences in volumes and profitability by subsector. The slowdown was felt most keenly by securities traders and building societies. While banks saw business fall quite sharply and profitability dip slightly, fund managers and insurance brokers fared much better.
One-off survey questions on the financial market conditions reveal that they are having a direct impact on several key aspects of firms' operations, and that they do not expect the storm to clear soon - seven out of every ten respondents (70%) believe the squeeze will last longer than six months. Meanwhile, a majority believe that further deterioration in credit conditions is likely over the next six months - 24% said the likelihood was high, and 65% said it was medium.
In a further sign of the impact of the credit squeeze, a survey-record proportion of financial services firms (24%) felt that their ability to raise funds would be a constraint on their growth over the next 12 months. This was a particular concern for building societies, with 92% of respondents from that sector flagging it as an issue. A record high of 36% of banks were also concerned that fund raising ability would constrain expansion.
Business sentiment among financial firms has worsened further in the past three months, with a balance of 49% saying they are less optimistic about the overall business situation in the sector than they were in September.
Total operating costs (excluding cost of funds), which had been expected to fall slightly, grew for a fourth quarter running (a balance of +17%), but are predicted to slow. Average operating costs per transaction grew at their highest rate (+19%) since December 1990 (+25%), but firms think they will stabilise.
Average spreads, the difference between the rates at which money is borrowed and lent, narrowed again (a balance of -15%) and are expected to compress further in the next three months. The value of non-performing loans, or bad debt, was unchanged from the previous survey, although it is expected to rise in the coming quarter.
Despite the shock of the credit crunch, new jobs continue to be created, though the rate of growth has been slowing over the past year, and is expected to come to a near standstill over the next three months.
An indication of the resilience of the sector lies in planned increases in capital investment, which are higher than three months ago and above their long-run averages, particularly for IT, where plans are at their strongest since September 1997. The main spur to invest remains to increase efficiency, and a much lower level of respondents now say they are investing to expand capacity.
Ian McCafferty, CBI Chief Economic Adviser, said:
"After two years of strong growth there has been a clear turnaround within the financial services sector. The credit squeeze has delivered a sharp shock to business volumes over the past three months, and it seems that difficulties are likely to persist for some time yet.
"This is however a very resilient sector that sees better prospects over the horizon, and it is encouraging that profitability, job creation and investment plans are all still positive."
Andrew Gray, banking partner, PricewaterhouseCoopers LLP, said:
"The financial services industry is concerned about the lasting implications of the credit squeeze and how long these ripples will be felt. Although results have revealed that 70% of respondents feel that it will take at least six months for market conditions to return to a normal level, this will be dependent on the health of corporates and on how current market conditions spread beyond financial services."
Analysis by sector
Banking
Business volumes fell quite strongly after a year of consistent growth and, since total operating costs (excluding cost of funds) advanced, banks’ average costs per transaction increased at their fastest rate since the end of 1990. Profitability fell slightly after a rather nondescript performance in 2007. Looking further ahead, banks’ investment intentions for the year ahead are very positive, particularly for land and buildings, but there was a record level of concern (36% of respondents) that further business expansion could be curbed by an inability to raise funds.
Building Societies
Building Societies were unanimously less optimistic than they were three months ago, the first time this has happened in the history of the survey, as the volume of business fell. It is expected to decline at a faster rate next quarter. Profitability fell at its fastest rate since September 1992, even though there was a large increase in spreads. This implies that firms are right to expect that faster falls in the volume of business next quarter will cause faster falls in profitability. Yet longer term signs are encouraging, with plans to spend much more on IT in the coming year and ongoing further headcount expansion.
John Hitchins, UK banking leader, PricewaterhouseCoopers LLP, said:
"The credit squeeze has led to a sharp fall in confidence in the banking sector. The lack of liquidity has dented business volumes and a steep rise in interest funding costs, as well as a fall in the price of some asset classes, has reduced profitability slightly. One encouraging feature is that business with corporates is on the up.
"Surprisingly, banks are split down the middle as to whether we will see markets return to normal in or beyond the next six months. Banks are, however, predicting non-performing lending to grow and this is likely to be in both the personal sector with mortgages refinancing at higher rates and the corporate sector where there are early signs of growing delinquencies."
General Insurance
Business volumes fell and are expected to do so again next quarter, though the level of business was considered to be close to normal. Profitability grew strongly this quarter, reflecting higher spreads and premiums paid, and a big rise in business with private individuals. Last quarter’s lack of growth in business with individual customers now looks like the outlier in a much improved trend evident in the past year.
Life Insurance
Life companies increased their profitability by cutting costs, though not quite at the pace seen in the third quarter. However, business volumes fell heavily, led by falls in business with individuals and companies, contributing to a mood of pessimism about the overall business situation.
Clare Thompson, UK insurance leader, PricewaterhouseCoopers LLP, said:
"The results of this quarter are mixed across general insurance and remain more optimistic than the life insurance sector. There is, however, some divergence in sentiment between personal and commercial insurers, a result of varying business environments, rather than the implications of the credit squeeze. Personal lines of business are currently performing better than their commercial counterparts who have seen premium rates fall over the second half of 2007.
"The life insurance sector is reporting further increases in profitability this quarter, underpinned by a sustained focus on cost cutting and greater efficiency. Pessimism still however mires this sector and the credit squeeze is likely to have a more direct impact on its revenues, particularly if we see a sustained downturn in the UK housing market. Spending on IT is expected to increase over the next year in order to improve efficiency and profitability and survey results have caught the first sign of a major new stream of regulatory spending, which is likely to be based primarily on Solvency ll and IFRS Phase ll."
Securities trading
Securities traders were unanimously less optimistic than they were three months ago, as the volume of business they saw contracted at a record rate, ending a year of growth before that. The sharpest contraction in business was with financial institutions. As total costs increased a little, and incomes fell, the impact of fewer transactions on profitability was severe. Further steep falls in profitability and volumes are anticipated for next quarter too.
Fund Management
Fund managers reported robust growth in business volumes, fees, commissions, employment and profitability, very strong investment plans for IT in the year ahead, and the slowest growth in total costs since December 2004. This improved picture was at odds with their lack of optimism, which reflects the greater volatility and more turbulent outlook for financial markets.
Pars Purewal, UK investment management and real estate leader, PricewaterhouseCoopers LLP, said:
"Recent market volatility has resulted in a fall in optimism among fund managers with higher spreads and costs per transaction flat, profitability has increased. Despite generally positive volumes and performance by major asset classes, there are certain asset classes, such as real estate, especially commercial property, which present a risk. Potentially significant deterioration in values is expected in the real estate asset class over the coming year and this risk could lead to further destabilisation. Product development is, however, on the rise and is an area of strong growth."