European bank investors prepare for loan loss provisions

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In its 123 years of existence, Barclays has never seen the prospect of such bad credit at the same time.

While the coronavirus lockout is wreaking havoc on global economies, a number will be at the center of concern when UK and European banks begin releasing their first quarter results this week: loan loss provisions.

Investors expect these fees to reach, and even beyond, levels never seen since the financial crisis, putting pressure on lenders’ already fragile business models.

Analysts have estimated that provisions for loan losses could quadruple or more in the first three months of the year, while bank profits could drop 50% on average across 2020. Worryingly, they warned that the worst was yet to come.

“The number of security provisions will dominate and rightly so,” said Jonathan Pierce, analyst at Numis. For UK banks, £ 1 billion to £ 1.5 billion per bank in addition to the normal fees for the first quarter “is not excluded”.

Line graph of supply charges as% of loans showing that estimates of loan losses have increased in Europe and the United States

At Barclays, which had recorded £ 448 million in impairment charges over the same period last year, “the burden we assume this year is double what it has seen since its incorporation in 1896” , he added.

The pressure is exacerbated by a new dynamic: “the forecast of provisions will only be guesswork,” said Pierce. This reflects both the unprecedented nature of the health crisis – with a lockout period still unknown – and the way in which the new accounting rules that force banks to recognize possible impairments much sooner than in the past will be implemented. .

Economists are already predicting the worst economic spillovers since the 1930s. Meanwhile, regulators, fearing that banks will suffer such losses that they limit their lending capacity, encourage executives to moderate their estimates until that the repercussions are clearer.

A leading indicator can be seen on Wall Street. The six largest US lenders increased their provisioning for first quarter loans by $ 25.4 billion – a 350% year-over-year increase – mainly due to potential write-downs on their credit cards and commercial loan books .

However, few expect European banks to be as conservative as their American rivals, in part because they are not profitable enough to fully bear the potential losses.

“In general, the United States tends to be faster in anticipation of losses than Europeans,” said Philippe Bodereau, portfolio manager at Pimco. “They charge bad debts much more aggressively and have more effective bankruptcy rules. In Europe, they tend to smooth losses over a much longer period. “

Stuart Graham, founder of Autonomous Research, added: “European banks will not experience a large similar increase. . .[because]regulatory messaging encourages banks not to be spoiled. “

Graham estimated that the bad debt provisions could wipe out an additional 25 billion euros from the profits expected by euro area banks for 2020. He had a warning: “Too many of our conversations involve the phrase” nobody have no clue “right now. “

Already in Europe, UniCredit – Italy’s largest bank, the most fragile banking market in the euro area – has announced that it will set aside an additional € 900 million to cover potential credit losses. Credit Suisse said last week that provisions for the first quarter had jumped 600% year-over-year. Deutsche Bank said on Sunday evening that it had set aside € 500 million in provisions for credit losses in the first quarter, up from € 140 million in the same quarter of 2019.

European banks are entering this crisis in a much weaker position than their American counterparts and are on average half as profitable. Years of extremely low interest rates weighed on their returns, while Wall Street rivals continued to steal market share in investment banking. All this means that the cushion for absorbing a significant peak of impairments is modest.

Measuring credit foam in global banks

Yet most investors believe that banks will be better able to withstand the fallout from coronavirus than during the 2008 financial crisis. On average, banks’ capital requirements are now 10 times higher and less active in risky trading activities. They also weren’t on the kind of “credit crunch” that preceded the last crisis, said one investor.

However, the crisis should further worsen their already poor incomes. UBS cut its profit forecast for the UK banking industry by a third this year and almost a fifth in 2021. So far, the benchmark for European banking stocks has plunged 42% this year and the British equivalent fell by 40%.

Deutsche Bank – which at its nadir in mid-March traded just 0.16 times the book value of its net assets – is now worth around 12 billion euros. The increasingly popular video conferencing company Zoom is valued at $ 50 billion.

Coronavirus will have a disproportionate effect on banks with retail and corporate business models. These lenders have high fixed costs to manage hundreds of physical branches, thousands of local employees and derive most of their income from interest billing, said a senior European banker.

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“Their margins are collapsing as interest rates go down, but their costs remain the same, while provisions for nonperforming loans are skyrocketing,” he added.

Investor concerns focused on unsecured personal loans – credit cards, personal loans, and auto finance – which in the Bank of England’s most recent stress tests had a cumulative loss rate of 25 % over five years. Barclays and Lloyds in the UK are particularly exposed.

For European banks that still have large market divisions, there may be bright spots. Hedge funds and ultra-wealthy clients jostling to reposition themselves amid market turmoil have been a boon for trading offices: On Wall Street, revenues from bond and stock exchanges have jumped nearly $ ” a third in the first quarter.

But these are small mercies for what an investor has described as “a sector without friends for several years.” The investor added: “Bank share prices were stressed before Covid and are now very distressed. It’s not like there is a lot of hope. “

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