Massive Credit Losses to Hit European Banks in Q2 and into 2021, Particularly When Debt Moratoriums Are Lifted

But the ECB went into high gear to soothe the pain of the banks.

The second quarter results of most large Western European banks will reveal further increases in expected credit losses as the economic outlook has “weakened substantially since the publication of 1Q20 results”, Fitch Ratings warns in its latest “Large European Banks Quarterly Credit Tracker.” This will put substantial pressure on the sector’s operating profitability.

European banks already had a profitability problem before this crisis began. The last time that average return on equity (ROE) in the sector reached the 10% threshold, which is broadly considered a healthy minimum, was in 2007, when the shares of European banks were at the highest level they have ever been. Since then, the average ROE of European banks has not come even close to regaining that level.

ROE was negative in three out of the five years that followed the share-price peak in 2007: in 2008, 2011 and 2012, as most European banks reported negative net income. Many would end up going under and getting bailed out or being absorbed by one of their somewhat healthier rivals. ROE began edging back upwards in 2013, reaching an 11-year high of 7% in 2019.

But in the first quarter, Covid hit, forcing many banks to provision for expected credit losses (ECL), with the result that sector-wide ROE slumped to 4%. Many large banks reported sharp drops in profits. Five big banks — HSBC, Deutsche Bank, Unicredit, BBVA and Societe Generale — posted net losses.

In the second quarter, more banks could take a hit if so-called “loan-impairment charges” (LICs) — an amount that a bank sets aside in case its customers cannot make the required loan repayments — rise sharply, Fitch warns.

At the 20 banks in Fitch’s analysis, LICs almost tripled year on year in the first quarter, to around €24 billion, eating up more than 55% of pre-impairment operating profit (compared with less than 20% in 2019). Fitch estimates that approximately half of the LICs “resulted from expected credit losses amid weaker macro-economic forecasts and management overlays on specific riskier loan portfolios, including the most vulnerable corporate sectors and unsecured consumer finance” [such as credit cards].

In the first quarter, the banks did not report a notable rise in impaired loans. But the main reason for that is that the economic fallout of the lockdowns had barely begun. As Fitch warns, impaired loans are “likely to increase significantly” in the second half of 2020 and into 2021, particularly when debt moratoriums are lifted.

Bad loans are still a problem in many parts of Southern Europe, including Italy, Portugal, Greece and Cyprus, a long-lingering legacy of the last crisis. Warnings are also being issued about a sudden surge of non-performing loans (NPLs) in Eastern Europe. The “Vienna” Initiative, a European bank coordination framework set up in the wake of the last crisis with a view to safeguarding the financial stability of emerging economies in Central and Eastern Europe, warned this week that banks in the region will soon be hit by a wave of bad loans that may last beyond 2021.

Continue reading the article on Wolf Street

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