You won't believe but banks are facing revenue headwinds

The banking sector's net interest income in 2Q has shrunk for the first time since 4Q09.

CIMB analyst Kenneth Ng said that the 2Q season raises questions on what the right level of ‘sustainable
profits’ is for banks. Inflated trading profits, he said were less of a feature in 2Q but loan growth slowed, margins narrowed, and credit costs deemed too low. Fee income franchises are still going strong, but can they last?, he asked.

Here's more from Ng:

Margins declined 5-9bps across the sector in 2Q12. Tighter pricing and higher funding costs were the culprits. Funding costs seemed to be more of an issue for  DBS and OCBC, than for UOB. For DBS, the key driver was a decline in China  margins as interest rate liberalisation led to tighter pricing and higher deposit  costs.

DBS saw a 60bps margin squeeze in China, contributing to a 2bps drag on  group margins. It was able to offset some of this with improvements in Hong Kong margins. In ASEAN, Malaysia margins remained stable while Indonesia’s margin squeeze is abating.

UOB saw group margins contract because its loan growth was towards larger, lower-yielding Hong Kong corporates. In Singapore, the ability to re-price corporate loans up seems to have been doused while
mortgage competition had intensified. Management guided for a slight margin compression ahead, but this would probably be more muted compared to the situation in 2Q. In Singapore, S$-deposit competition by foreign banks does not seem to weigh down on NIMs as the local banks are still flush with S$-liquidity, and are prepared to let time deposit share erode. Instead, funding pressures have been coming from banks raising alternative debt financing. DBS raised another S$1bn in Tier-2 sub-debt
(3.1%) in August.

Outlook not as bad for non-interest income. Banks performed surprisingly well on their non-interest income line in 2Q. We did see a general slowdown in stockbroking, investment banking and wealth
management in 2Q12 but contributions from trade-related and loan-related fees were rather strong.

Some of the drivers for the latter are fading with loan-growth slowing, but contributors such as bancassurance commissions and credit card fees look more stable than others that depend on corporate activity, which is a reason why we prefer UOB now. For the past two years, DBS used to have rather strong treasury-related earnings as its customer cross-sell initiatives drove this revenue line but that seemed to be tapering off even if CEO Piyush Gupta reckons that the level in 2Q was lower-than-normal and could normalise back up.

UOB did have some AFS gains in the quarter but these do recur from quarter-to-quarter; the quantum in 2Q was not that large and it was not necessarily all that inflated.

On the bright side, equity deal flow was very weak in 2Q though debt deal flow was decent. (OCBC did surprisingly well on investment-banking fees in 2Q, DBS and UOB did not.) Investment banking fees might blossom in 3Q as more equity deals are completed, so it is not necessarily all that bad.