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Coronavirus brings eerie déjà vu to European banks' bad loan battle

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Coronavirus brings eerie déjà vu to European banks' bad loan battle

The global coronavirus pandemic is reverberating into Europe's banking sector, potentially putting in peril the years of post-financial crisis work dedicated to restoring asset quality even as state and regulatory support efforts get underway.

"At best the impact is a further weakening of nonperforming loans and profitability [ratios], and at worst you could see an important backlash from financing to the energy sector and from a credit crunch to small and medium-sized enterprises," Daniel Lacalle, chief investment officer at fund manager Tressis Gestión, said in an interview. With the price of oil plunging during the week of March 9, banks' exposure to energy as well as oil-reliant sectors has been in the spotlight.

Meanwhile, Lacalle said that because European banks finance 80% of the real economy, "companies really depend on bank credit."

Generally during any sort of economic shock, there is a lag before banks begin seeing the quality of the assets on their balance sheets deteriorating as bankruptcy levels and employment rates, among other factors, are negatively affected, Maria Rivas, senior vice president of global financial institutions at DBRS Morningstar, said via email.

"It looks likely that we could see a spike in asset quality problems in the next six months if the situation becomes more challenging, particularly in SMEs and consumer lending," she said.

SME, consumer lending

But plans are underway to minimize any possible coronavirus-related blows to banks and other parts of corporate Europe.

The European Central Bank on March 12, while leaving its rates on hold, said it is planning additional longer-term refinancing operations to the end of the year to help boost liquidity to the financial system to stem impacts on the coronavirus.

Preemptive measures have also been unveiled in the U.K. In announcing a £30 billion stimulus package on March 11, the day when the number of confirmed coronavirus cases in the country reached 456, the U.K. government unveiled a £1 billion plan to enable banks to offer business-interruption loans of up to £1.2 million each. As an incentive for banks, the government said it will cover as much as 80% of potential losses on these loans.

Earlier that day, the Bank of England cut interest rates to 0.25% from 0.75%

U.K. SMEs are already feeling the strain of COVID-19. In a survey this month by MarketFinance, a U.K. business finance company, of 2,000 SME owners in the country, 36% said that without securing some form of finance over the next six weeks, their businesses are unlikely to survive, while 69% reported significant pressure on their cash flow, largely because of the impact of the virus.

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Yet despite stimulus measures such as the U.K.'s, past asset struggles triggered by the financial crisis of 2008 could come back to haunt European banks. In many cases, it has taken banks years to pare down nonperforming loans, or NPLs.

In Spain, whose economy was one of worst affected by the crisis, Banco Santander SA and Banco Bilbao Vizcaya Argentaria SA, among others, have seen their sector's NPL ratio fall to 3.37% at the end of the third quarter of 2019 from 8.11% at the end of the fourth quarter of 2014, S&P Global Market Intelligence data shows, largely through the sale of bad loan portfolios to investors, as banks in other parts of Europe have also done.

NPL ratios have "come down fundamentally because [banks] have sold NPL portfolios to investment firms," Lacalle said. However, he added, "those investment firms are going to stop buying nonperforming loan portfolios as of 'yesterday,'" since there is only so much appetite to soak up bad assets being offloaded in European economies showing minimal or no growth.

Italian measures

Italy is a particular area of focus. Its government on March 9 placed the country on lockdown, implementing quarantine for about 60 million people at a time when Italian banks such as Unione di Banche Italiane SpA, Banco BPM SpA and Banca Monte dei Paschi di Siena SpA are still dealing with their bad loan books accumulated during the financial crisis.

The Italian banking sector's NPL ratio fell to 7.40% in the third quarter of 2019 from 16.53% at the end of 2014, according to S&P Global Market Intelligence data, but the level remains higher than elsewhere in Europe. In Germany, the ratio dropped to 1.21% from 3.92% during the same period, while it declined to 2.59% from 4.16% in France and to 1.80% from 3.37% in the Netherlands.

"We've had a reduction of NPLs on Italian banks' balance sheets over the last four to five years, but it's going to be the next stress point to keep an eye on," said Christopher Dembik, an economist at Saxo Bank.

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Italy has suspended the payment of tax bills, which should lessen the liquidity burden on SMEs and self-employed workers in the country, Marco Troiano, deputy head of financial institutions at Scope Ratings, said via email.

"Moratoria on debt payments would also help these borrowers, though it may weaken the banking sector if they had to recognize upfront large volumes of NPLs. This is why I think politicians are pushing for flexibility from the supervisors," he said.

Regulatory flexibility

Rivas of DBRS Morningstar said banks in countries that are providing stimulus measures can expect margins to be hit as a result but fortunately banks are in a stronger position in terms of liquidity than when the financial crisis hit.

The question is whether more can be done for Europe's banking sector.

France's Finance Minister Bruno Le Maire has called on European authorities to relax rules on how banks classify nonperforming exposures with a view to giving them more flexibility to help companies hit by coronavirus-related slowdowns.

A spokesperson for the European Banking Authority said it was "monitoring the evolution of risks in banks" and focusing on their contingency plans. Citing the coronavirus, it announced on March 12 that it is delaying the Europe-wide bank stress tests to 2021 after having launched them in January with a view to completing them in July.

Dembik said he expected authorities to ensure banks have enough liquidity to continue lending to businesses. But if there were a significant rise in NPLs, regulators would likely find a way to intervene, but only over a fixed period of time, he added.

"It has to be temporary with a precise calendar otherwise we are going to open up the hatches and that will pose a real problem in terms of financial stability."