Delinquencies give few alarms but asset quality slump pending

While aggregate delinquency data currently looks benign, asset quality is expected to deteriorate as support programmes come to an end.

Up to date aggregate delinquency data, while masking some divergence, holds no terrors, notes Scope Ratings. The NPL ratio for EU-headquartered banks fell to just 2.5% at the end of 1Q21, according to ECB numbers, while gross euro area NPLs more than halved between 4Q14 and 4Q20 from €998bn to €443bn thanks to effective offloading mechanisms and solid demand.

‘’Banks have come through the pandemic crisis broadly unscathed. Markets have responded to fiscal and monetary stimulus, and public and bank support programmes have led to reduced corporate insolvencies relative to initial forecasts. Banks continued to lend, buoyed by TLTRO and other measures, and robust capital buffers,’’ says the rating agency.

However, as ECB vice president Luis de Guindos said in a recent speech, while bank results have beaten expectations, the key drivers of this resilience have been lower provisions and solid trading earnings and neither of these is sustainable over time.

Net interest income remains under pressure and, as Scope has previously noted, the profitability outlook is cloudy and banks will struggle to clear their cost of equity.

The pace and nature of economic recovery are the critical factors. These are already unequally distributed across countries and sectors. If growth stumbles and inflation turns out to be more stubborn than central banks would currently have the markets believe, banks will need to review their provisioning.

Indeed, if the current benign scenario is made possible only by public support, these stimulus measures might in fact have simply prolonged the lag between the recession and the rise in NPLs rather than prevent NPLs outright, says de Guindos.

Scope states: ‘’Given the sharp reduction in the use of legislative moratoriums, we see no need for these programmes to continue. Any remaining hardships, for example in hospitality or transportation, should be dealt with directly through grants. Governments should also withdraw public guarantees for new lending. Few countries have made extensive use of public guarantee schemes.’’

The agency concludes: ‘’Depending on the Covid exit paths of the respective economies, we expect these programmes to be phased out gradually. Restoring proper accounting of NPLs will greatly enhance transparency for bank investors and strengthen the confidence in stronger banks. Where necessary, regulators could temporarily lengthen calendar provisioning for new NPLs incurred because of the crisis, for example for government-guaranteed loans.’’

Asset-quality deterioration and NPL recognition was the first of the ECB’s four-part FAQ about the raft of forbearance measures to help banks weather the crisis. Banks were guided to mitigate volatility in regulatory capital and financial statements from IFRS 9 accounting by implementing transitional arrangements.

Under transitional IFRS 9  arrangements - extended under last year’s quick fix CRR amendments - banks are allowed to replenish CET1 capital with any increase in expected provisions recognised in 2020 and 2021 for assets that are not credit-impaired relative to end-2019. Supervisors, meanwhile, have adopted a more flexible approach to processes, timelines, and deadlines.

Stelios Papadopoulos