Do the banks have a Plan B?
Now that consumer spending is slowing down, the banking sector needs to look for new sources of growth.
British banks have investors worried. Not because of their current profitability, which is healthy, but because a slowdown in the economy may hit this industry harder than most.
The banking sector still continues to make profits. In August, for example, HSBC made a half-year profit before tax of $10.6bn (£5.94bn), 5 per cent more than the same period in 2004. Its profit attributable to shareholders rose 9 per cent to $7.6bn over the same period a year ago.
Investors fear that as consumer spending continues to slow, banks that have relied on high street spending have yet to produce a contingency plan to fall back on for growth. Jon Thornton, the head of British equities at Gartmore, summed up much of the current thinking, saying: “The markets are worried where future growth will come from.”
And he added: “Most banks have made a lot of profit on consumer spending. But if that slows, it could mean an increase in bad debt. And rises in bad debt write-offs is the last thing an investor wants to hear.”
Much of the recovery in the British economy since the 2000 tech bust has rested on high street spending and house buying, as activity such as the buy-to-let market has boomed. This allowed banks to lend cash to millions of consumers to buy new homes and kit them out.
It adds to the current climate among banks, which is intensely competitive. As high street spending has slowed banks have looked to corporate spending to pick up the slack.
Mid-cap companies upwards now have the leverage to force their banks to refinance existing credit facilities, for more cash, with companies sometimes cutting their basis point margins in half. In addition, banking covenants — the terms a company must agree to — are more lenient than ever before.
In this environment finance directors have become heroes in the eyes of their boards, for bringing in more money to their companies at lower rates than ever. It is this cheap money that has been funding the increased corporate mergers and acquisition activity over the last year.
By contrast, smaller banks, which have had strong links with companies, have been forced to drop out of banking syndicates because they cannot make a profit on such low margins.
Thornton said: “In terms of banks going after corporate clients the competition is rampant. The squeeze on margins is immense. As regards the consumer, there are an awful lot of banks in that space all chasing the same customer, who is spending less.”
Observers point out the banking industry is similar to the hotel business in that they operate in global markets, where consumer spending is the key factor.
Bigger banks know a way to continue growth is via foreign acquisitions. So much consolidation went on in banking throughout the 1980s and into the 1990s — the last of which came with the Royal Bank of Scotland’s £21bn takeover of NatWest in 2000 — that few observers believe that British competition authorities would allow very much more domestic M&A activity.
Thornton said: “We may see more consolidation on the global stage. And Asia may be the area where we will see purchases being made. Some of the best performing banks at the moment are HSBC and Standard Chartered, who have extensive operations in this area.”
Over recent months some observers think we have seen early purchases that may lead to another wave of banking consolidation that began 20 years ago.
Last month Dutch bank ABN Amro’s €3.2bn (£2.2bn) purchase of a 39.4 per cent stake in its Italian rival Banca Popolare Italiana Scarl, giving it just over 69 per cent of the bank overall, was seen as an early green shoot.
In July Barclays Bank bought 53.9 per cent of South African bank Absa for £2.6bn and the British bank said it would continue to look for further acquisitions abroad.
If banks are to stop trading as discounts to their share prices they may be forced back on the acquisition trail. However, domestic competition law and complex European regulation may increasingly send British banks to all parts of the globe to buy rivals, such as Latin America and parts of Africa and Asia. And in comparison to some of these regions the Italian banking system is considered a model of probity