The financial services sector has endured another difficult quarter, as business volumes continued to fall at a sharp pace while numbers employed and profitability fell at their fastest rates in five years, a new survey said.
The latest Financial Services Survey from the CBI and PricewaterhouseCoopers LLP also revealed that these firms expect to find it significantly more expensive to access finance for investment purposes, and that they fear the credit squeeze will get worse over the coming six months.
Business volumes fell sharply, as 17 per cent of respondents said volumes had grown in the three months to early March, while 47 per cent said they had decreased. The resulting balance of -30% followed December’s near 17-year low of -33%, and was worse than expected. A similar rate of decline is expected over the coming three months.
A record balance of respondents (-44%) reported a fall in the value of fees, commissions and premiums, while income from net interest, investment and trading also fell sharply again. Both of these income categories are expected to fall heavily again over the next three months.
Total operating costs (excluding the cost of funds) grew, although this was at a slower rate than the previous four surveys and they are expected to be flat over the next three months. Average operating costs per transaction fell back slightly, after growing at the fastest rate in 17 years in the last survey, and this measure is expected to fall markedly over the coming quarter.
The sector’s profitability has dipped sharply, after holding up last quarter. The balance of 18 per cent reporting a fall was a weaker figure than expected and the most negative since March 2003 (-19%). On a more positive note, profitability is expected to stabilise in the coming three months.
A net 25% of respondents said they had cut jobs over the past three months, which is the highest rate since March 2003 and against expectations that numbers employed would increase marginally. Firms’ expectations for employment over the next few months (a balance of 33% expecting numbers employed to reduce) were the weakest since December 2002.
Plans for capital investment in the year ahead are very weak, with plans for spending on IT flat, and intentions for land and buildings, and vehicles, plant & machinery the lowest since June 1992. Marketing expenditure plans have picked up, however.
Trends in patterns of lending to different types of borrower illustrate the way in which the credit squeeze is feeding through.
The amount of lending to private individuals fell sharply again in the three months to March, and the balance of -28% reporting a decline was the weakest since March 1991 (-45%).
Lending to industrial and commercial companies continued to increase, however, at a slightly faster rate than recorded in December. A balance of 8% nevertheless expects lending to these customers to contract in the next three months, while lending to other domestic customer bases is also expected to decline.
As financial institutions adapt to the credit squeeze, average spreads, which measure the difference between the rates at which money is borrowed and lent, were felt to have widened strongly (a balance of +35%). This was the largest gap since March 1993 (+48%). The value of non-performing loans, or bad debt, rose very slightly but is expected to grow faster next quarter.
Even more firms think the credit squeeze will be prolonged than did so three months ago – 90% believe it will last longer than six months compared with 70% last quarter, despite firms being a further 3 months into its effects. Nearly all businesses (97%) believe there is a good chance that credit conditions will get worse over the next six months – 35% said it was a ‘high’ likelihood and 62% saying it was ‘medium’.
The growing impact of the credit squeeze is also evident in the proportion of firms saying their ability to raise funds will be a constraint on business growth in the coming 12 months. Forty per cent of firms saying this would be the case, up from 24% last quarter, is the second consecutive record figure reported. This is largely due to the record proportion of banks expressing concern that fund-raising ability will constrain expansion – this quarter’s 66% set a new high, after a record 36% last quarter. The proportion of building societies concerned about this was also very high (83%).
Business sentiment among financial services firms has continued to worsen, and a balance of 29% reported that they are less optimistic about the overall business situation in their sector than they were in December.
Ian McCafferty, CBI Chief Economic Adviser, said:
"It is clear that the credit crunch has worsened over the first three months of this year. The interbank markets have become more gummed up, with banks even more unwilling to lend, and credit spreads have widened.
"While liquidity injections and interest rate cuts by the Bank of England will help shore up the system, neither will solve the fundamental problem of restoring trust, so that credit markets are unlikely to return to anything like normality for some time to come. Even when they do, we will not see a return to the very favourable lending conditions that existed before August.
"We can expect further tough times in the financial sector, and as this feeds through into the wider economy it will inevitably be felt through slower economic growth this year and next."
Analysis by sector:
Business was well below normal in volume terms. Banks’ volumes fell at their fastest pace since September 1991, while their income also fell strongly, (that from fees and commissions at the fastest rate since this survey began in 1989). Banks managed to widen spreads, and plan to do so again, while non-performing loans showed only a marginal rise. Even so, profitability fell, and banks have begun seriously pruning staffing levels, with the fastest fall in numbers employed since September 2000. Investment intentions have also turned negative, even for information technology, on reduced inclinations to expand capacity, reach new customers and provide new services.
Building Societies increased their spreads and their volume of business – though the latter was still well below normal – and hence were able to lift profitability this quarter. They were less optimistic than they were three months ago, however, as they expect the volume of business to contract very strongly next quarter, with some limited downward pressure on spreads. As a result, while there was an unexpected uplift in the trend in profitability this quarter, societies expect this to be transitory. Even so, they still plan to invest much more on IT in the coming year, as well as much more on regulatory compliance.
Andrew Gray, UK banking advisory leader, PricewaterhouseCoopers LLP, said:
"Banks are increasingly concerned about the economic outlook for the second half of 2008 and while there are some signs of optimism, the markets remain fragile. Although banks have seen their funding costs stabilise, liquidity is still tight and market conditions have left them reluctant to lend to each other, commit to capital spending and invest in new services or customer acquisition. Many banks are predicting staff levels to decline, although evidence suggests these reductions will be reasonably modest.
"Despite market conditions and a mortgage demand slowdown, building societies remain quietly confident in their ability to fund and manage their business. Although activity is expected to slow and the availability of funding to limit new business growth, spreads have widened and the sector’s improved sentiment is reflected in the strength of IT and staffing investment plans."
Business volumes grew at their strongest rate since June and are expected to do so again next quarter, while the level of business was considered to be well above normal. Profitability grew very strongly this quarter, reflecting much higher spreads and a big fall in average transaction costs, as well as the growth in business. The big fall in average transaction costs and bullish projections for IT investment in the year ahead suggest greater use of the internet to transact. General insurers also expect that the strong growth in profitability will continue next quarter.
Life companies’ optimism collapsed, as while volumes of business, incomes, value of new business and profitability all fell, they expect all of these trends to accelerate next quarter. Numbers employed fell heavily and are expected to do so again next quarter. Looking forward to the coming year, life companies expect to spend much more on regulatory compliance, and more on marketing, but they are intending to authorise less capital expenditure than in the past year.
Andrew Kail, UK Insurance leader, PricewaterhouseCoopers LLP, said:
"The general insurance sector is reporting that it feels reasonably well insulated from the direct effects of the credit crunch with most players appearing to have minimal exposure to impaired investments. More generally, performance diverges between personal and commercial lines of business, with the latter seeing more pressure on rates, but the results show that many general insurers remain confident with their strategy and business model.
"Life insurers however are much more pessimistic. They report a large fall in confidence as the continued investment and housing market uncertainties directly affect their business. Faced with this uncertainty the life insurers are increasingly focused on cost reduction and reductions in capital expenditure and staff costs are likely despite them reporting a need to make further investment in the area of compliance and regulation."
Securities Traders’ optimism fell for the third successive quarter, as their volume of business and stream of revenues from fees, trading and investments both contracted at a strong rate again. After expanding their headcount for three years, this quarter’s fall in numbers employed suggests that securities traders are recognising the more difficult outlook. This is also seen in expectations that marketing budgets will be flat, and that the growth in IT spending will decelerate in the year to come, relative to last year.
Fund managers were the only sector to report that they were more optimistic than in December and are continuing to expand their headcount aggressively. Business volumes grew for the second quarter running, which helped to lift profitability despite downward pressure on the value of incomes derived from trading, investments, fees and commissions. Next quarter firms expect to see profitability weaken, however, as they expect that volumes will be lower and that there will be continuing pressure on incomes.
Robert Mellor, financial services tax leader, PricewaterhouseCoopers LLP, said:
"Despite recent equity market falls and unprecedented levels of volatility, confidence in the fund management sector is on the up. Revenue growth has emerged as the sector’s greatest worry and a return to ‘normal conditions’ is not expected before year end. Respondents are increasingly concerned about the risk of asset write downs and a stronger focus on asset allocation will be a key feature of 2008.
"Securities traders have seen a further decline in confidence this quarter. Business volumes and revenue streams are all down and the sector’s growing recognition that some of its businesses face a long road to recovery is reflected in staffing plans as we witness an increasing desire to match cost structures to the prevailing market conditions."