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.

By Nick Corbishley, for WOLF STREET:

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.

The Vienna initiative is anticipating three waves of bad loans: a first wave in the fourth quarter of this year as anti-Covid stimulus measures expire and struggling borrowers begin defaulting; a second, slower and more spread-out wave that may follow in the first half of 2021; and a third wave, resulting from the contagion effects of failures in different parts of the economy and supply chains, that is likely to appear towards the end of 2021.

As bad loan ratios surge, capital ratios will continue to decline in Q2 for many banks, Fitch warns. But it expects that large European banks will maintain sufficient buffers above regulatory requirements, which have been relaxed due to the crisis.

The EU’s banking watchdog, the European Banking Authority, concurs. Although it expects banks to suffer a capital hit of up to €380 billion as a result of the economic disruption from coronavirus, it believes that most banks’ capital position is much stronger than before the Global Financial Crisis. At the end of 2019, banks had on average capital equivalent to close to 15% of their risk-weighted assets, compared to just over 5% in 2011.

“The starting position of the banks [was] very good at the end of last year [and] the measures put in place since the last crisis have held up,” said José Manuel Campa, chairman of the EBA, in May. “As a result of all that, the buffers are large and should be sufficient in the short term so we are not worried about [the banks’] short-term ability to lend to the economy and in the long term to have sufficient buffers to absorb the eventual losses,” he added.

Just in case those buffers aren’t large enough, the ECB set out to enhance bank profits that would build those capital buffers. On Friday it revealed that it had offered banks a record €1.3 trillion of loans priced at negative -1% as part of its new TLTRO-III program, in part to make up for the profit-squeezing effects of the ECB’s negative interest rates.

In total 742 banks tapped the program, meaning that the average take-up per bank was €1.8 billion, twice as high as the previous record set in December 2011. More than half of the money disbursed will be used to repay earlier ECB loans that are about to mature.

These loans at a negative rate of -1% will result “in a gross transfer to banks of around €15 billion” over the next 12 months, says Frederik Ducrozet, strategist at Pictet Wealth Management. “Most banks should qualify. Add tiering and here you are: from NIRP to a net transfer to banks!” The ECB is also weighing a Eurozone-wide bad bank to remove up to €500 billion of bad debt off banks’ balance sheets. By Nick Corbishley, for WOLF STREET.

A new tsunami of bad debts washes ashore in Italy while banks are still struggling with the debris from the prior tsunami of bad debts. ReadItaly Once Again on the Eurozone Worry List

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

  1. Engin-ear says:

    “The Vienna initiative is anticipating three waves of bad loans” ….in 2020-2021…

    Nick, that’s a real ipiece of nformation with real analysis and courage to see what’s coming without excessive drama and rumors and wishful thinking.
    Thanks for bringing it here.

    Keep posting.

  2. MonkeyBusiness says:

    I am betting on a minimum of one major bank failure.

    Italian banks failing might be a Credit Anstalt moment.

    • sunny129 says:

      They are NOT allowed to fail, since they are interconnected.

      When they are adding NIRP to buttress the bottom line( record €1.3 trillion of loans priced at negative -1% as part of its new TLTRO-III program)!

      Things are desperate and ECB will do whatever needed!

  3. Sound of the Suburbs says:

    The economics of globalisation has always had an Achilles’ heel.
    In the US, the 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression. No one realised the problems that were building up in the economy as they used an economics that doesn’t look at debt, neoclassical economics.
    Not considering debt is the Achilles’ heel of neoclassical economics.

    Who would have expected we would get problems with debt?

  4. Tom Stone says:

    I’m sure this will buff right out, it’s contained.
    What could go wrong?
    Have some Gelato, chill out.

  5. leanfire_Queen says:

    Let’s face it, deflation is what savers deserve after 10 years of ZIRP to help debtors out.

    Debt mountains in the US and Europe should explode like massive volcanoes, which will benefit saves a great deal. The pricing mechanism will take care of rewarding savers.

    Capitalism without bankruptcy = Catholicism without hell.

  6. VeryAmused says:

    “More than half of the money disbursed will be used to repay earlier ECB loans that are about to mature.”

    Soon to be…

    “All the money disbursed will be used to repay earlier ECB loans that are about to mature.”

    If you shake it more than three times you are just playing with yourself.


  7. Marlin says:

    I wonder, when the first negative rate 10-year mortgages will happen. You buy a house on credit and get paid for living in it. Wouldn’t that be nice?

  8. Bob Hoye says:

    Somehow “Creditanstalt” comes to mind.
    A big bank in Austria that in 1930 was forced to bailout a lesser bank.
    It was the “news” that in mid 1931 brought the financial markets down.
    Its failure did not itself collapse the markets.
    That contraction was consequent to the preceding bubble that completed in 1929.

    • sunny129 says:

      Because they all are interconnected, more than many assume. When tide goes down, we will know!

      Fed will jump into the rescue (just like in 2008) in the name of global financial stability.

  9. Joe says:

    In Canada, the government is encouraging debt deferrals and extension of mortgages.
    Meanwhile, the banks and credit agencies are not in this game and will enforce their agreements and put debt default on files. Most of this is totally computerized.

  10. Marc 60 says:

    Wow what a surprise all the banks are actually bankrupt and of course will just get super loans to pay off their existing debts whilst getting into newer and larger debts.

    The whole system is completely fake none of it is real it is all supported by fake newly conjured out of thin air money to constantly repay the previous debts to make things all look good.

    IMHO sooner rather than later these same people that have taken to the streets over Police brutality are going to actually have no where to live, no food to eat and no health care. They will then start to also realise just what this money game has been and that it has been at their expense. Now when this happens we really are going to see rioting in the streets and the will to burn it all down and its going to be a lot more then just a little bit messy.

    • Beardawg says:

      Marc 60

      I agree with your statements and observations. The problem with your analysis, however, is that this will be the classic frog in lukewarm water. As the water heats to a boil (2 years? 10? More?), the frog (disenfranchised peoples) boil to death with no awareness. Many ways that could look, but existing inner city welfare / social structuring might be a glimpse. At some point, people will get 3 Square meals, a free roof over their head and at least semi free healthcare. Water will be boiling, freedom gone (death), but it’s better than (fill in name of 3rd world country here).

      • CRV says:

        Actually scientist have tried this frog-theory and observed the frog would indeed stay in water at a higher temperature then when it was put it in at a slightly lower temp suddenly. But the frog refused to be cooked and jumped out long before any physical harm was done.
        There is hope for humanity i guess.

  11. WES says:

    Nick is Just giving a blow by blow description of the European central bank’s Ponzi scheme’s current operations.

    On this side of the pond, Wolfe gives us the scoop on the Fed’s Ponzi scheme’s current operations.

    How in hell did we ever let our world be run by a bunch of ignorant money printers?????

    • sierra7 says:

      “How in hell did we ever let our world be run by a bunch of ignorant money printers?????”
      Way back when Manhattan was “purchased” from the indigenous peoples for trinkets.
      It’s our turn now….we are and have been the sellers……..

  12. MiTurn says:

    I’m curious to see how this stress on the banks, especially the differential between northern and southern, will impact EU solidarity. A tough row to hoe.

  13. Anton Koch says:

    The ECB told the banks to relax their rules for the time being. The banks shall not pressure companies that are getting behind with their debt interest payments and amortizations until the virus disappears.
    Therefore the banks losses will only increase for the banktrupties of private persons and small businesses.

  14. Bruce Westin says:

    If banks create money out of thin air when they make loans the default rate would need to be extremely high for them to lose money???

  15. sunny129 says:

    “These loans [ECB loans to banks] at a negative rate of -1% will result “in a gross transfer to banks of around €15 billion” over the next 12 months, says Frederik Ducrozet, strategist at Pictet Wealth Management.”

    Another ‘Extend & pretend’ maneuver and kick the can down. Rating agencies are acting just like prior to GFC! Reluctant to announce ‘the emperor has no clothes’ The whole global banking system is farce with creative accounting methods to keep the assets floating high!

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