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COVID-19 could spark longer-term pivot on credit risk

Banking Essentials Newsletter December Edition Part 2

Banking Essentials Newsletter - November Edition

University Essentials | COVID-19 Economic Outlook in Banking: Rates and Long-Term Expectations: Q&A with the Experts

Estimating Credit Losses Under COVID-19 and the Post-Crisis Recovery


COVID-19 could spark longer-term pivot on credit risk

Editor's note: This is the second of a three-part series looking at the longer-term economic and financial impact of the COVID-19 pandemic in Latin America. You can read the first part here, and the third part here.

The impact of COVID-19 forced Latin American banks to take huge provisions to absorb credit losses that could take months to materialize. But the pandemic also may lead some banks to shift their lending strategies for years to come.

"If pre-pandemic loan growth strategies in LatAm were already cautious or conservative, I would say that COVID will have just accelerated this posture going forward," Alfredo Calvo, a bank director with S&P Global Ratings, said in an interview.

Latin America has been among the regions hardest hit by COVID-19, pushing banks and regulators to grant credit relief to borrowers who may have otherwise defaulted. But the efforts also have clouded expectations of where credit deterioration ultimately will land. Many believe that banks will see a notable uptick in defaults once the relief measures end, but the magnitude is still a mystery that may not be fully known until mid- to late 2021.

Banks across the region have bulked up provisions in anticipation. But many banks also have adopted far more defensive lending standards, particularly to small and medium-sized enterprises and lower-income individuals. Both groups have been especially hard hit by the pandemic's economic effects and are expected to take longer to recover.

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But for banks, they are also higher-margin lending segments and so their shift away has contributed to tighter net interest margins, analysts say. Average spreads in Brazil, for instance, have narrowed by about 8 percentage points since February.

Even after pandemic-related risks subside, experts expect banks to maintain their more cautious stance within both consumer and SME lending.

Consumer lending

In individual lending, "we will likely see a migration in retail loan books toward secured products such as mortgage, auto loans and payroll," Calvo said. "Credit card and personal loans will decelerate."

In many economies, the recovery in unemployment rates will largely dictate when banks begin to ease back into such loans. During a recent earnings conference call, Banco Santander México SA CFO Didier Campos stressed that consumer lending will "depend on the speed of job creation."

And it could take years for unemployment rates to return to their pre-pandemic levels. In many countries, official unemployment rates have still not peaked as health risks and emergency aid has kept many workers from seeking jobs. But as financial aid expires and perceptions that the pandemic's end is in sight take hold, many could soon look to return to the labor market.

"The market is weaker than headline numbers suggest," Elijah Oliveros-Rosen, a senior economist with S&P Global Ratings, wrote in a report. The unemployment rate is expected to rise quickly in more major economies. In Colombia, the unemployment rate is seen hitting 16.1% by the end of 2020, compared to 10.5% a year ago.

SME lending

Lending to SMEs already was "clearly underweight" in Latin American bank portfolios relative to their GDP contribution, Alejandro García, Managing Director with Fitch Ratings, noted in an interview. That may become even more pronounced in the years to come.

"It is clearly the hardest struck sector by this crisis," García noted. "It will be a segment that will surely take long to recover, and looking into the next two to three years, it could well lose relative weight in the portfolio mix."

Thanks largely to government relief measures, banks' exposure to the SME segment has yet to show up in their nonperforming loan books. But it is still uncertain what will happen now that support measures are ending.

"We have been trying to persuade regulators and development banks to [extend] the guarantee program for the benefit of SMEs. But we have not been able to convince them so far," said Didier Campos, CFO with Santander Mexico, in the bank's most recent earnings conference call. "We are being very cautious on SMEs."

Better than expected

Overall, however, banks and experts have been pleasantly surprised by the limited scope of credit deterioration to date. NPLs have remained subdued as of third quarter-end, and Latin American banks have managed to renegotiate terms for about $300 billion worth of loans. The results have been much better than expected, S&P Global Ratings' Calvo argued.

To be sure, some analysts are still wary of how those loans will perform once aid fully expires. "We have yet to see how the private sector will deal with withdrawal," Martin Castellano, head of Latin American research with the Institute of International Finance, said in an interview. "Households and companies might wind up unprotected."

Banks have piled up provisions during the year as they anticipated loan losses down the line. However, "uncertainty around the shape and pace of recovery make it difficult to judge if loan loss provisions will be sufficient to absorb losses," analysts from Moody's wrote in a recent report.

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