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European banks able to cope with bad loans, as UK banks release provisions

Banks across Europe set aside lower provisions for potential loan losses in the second quarter, with British banks booking significant reversals, and the risk of bad loans piling up is manageable, according to analysts.

Twelve of the 25 largest banks in Europe booked reversals of provisions in the second quarter, meaning their overall funds to account for bad loans shrank. Loan loss provisions are put aside by banks to cover potential costs arising from loans that default.

Five of the 12 — Barclays PLC, NatWest Group PLC, Lloyds Banking Group PLC, HSBC Holdings PLC and Standard Chartered PLC — are based in the U.K., with Barclays releasing the highest amount of €911 million, according to S&P Global Market Intelligence data.

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Some banks were able to release provisions after upgrading their macroeconomic assumptions as economies exhibited more indicators of a rebound, according to Giles Edwards, senior financial services ratings director at S&P Global Ratings.

Proactive provisioning

U.K. banks more proactively provisioned than many European peers at the onset of the pandemic, and there was a faster-than-expected economic recovery in the first half, Ratings said in an Aug. 10 report. The agency has forecast 7.0% GDP growth in 2021.

Assuming there is no major COVID-19 flare-up, the U.K. banking sector's second-half credit loss charge might be about zero, Edwards said in an email. Ratings' credit loss assumption forecast for the full year may also now be too conservative, he said.

Swiss banks UBS Group AG and Credit Suisse Group AG, along with several lenders based in Belgium, the Netherlands and the Nordic region, also booked reversals. Banks that released provisions were those that put aside substantial sums last year, partly reflecting a more conservative approach to the impact of COVID-19, Maria Rivas, senior vice president at DBRS Morningstar, told S&P Global Market Intelligence.

Large banks in Spain, France and Italy, including Banco Santander SA, Banco Bilbao Vizcaya Argentaria SA, BNP Paribas SA and Intesa Sanpaolo SpA, continued to maintain provisions of more than €500 million each in the second quarter, although in each case this figure was significantly lower than a year ago.

Some other banks that have not yet released provisions, for example those in France, are likely to follow suit as they factor a better economic outlook into their assessment of assets, Dierk Brandenburg, managing director and head of financial institutions at Scope Ratings, said in an email.

Not all are likely to release large amounts, however, as write-backs could be offset by top-ups in other portfolios, according to S&P Global Ratings' Edwards.

'Short-term boost' to profitability

Helped by lower provisions, all 25 banks in the sample generated more net income in the second quarter, except for Credit Suisse, Spain-based CaixaBank SA and Germany's Commerzbank AG.

CaixaBank, which reported a loss of €605 million, was affected by its merger with Bankia SA, while Commerzbank, which reported a loss of €527 million, incurred expenses for its ongoing restructuring. Credit Suisse's lower net income was impacted by losses related to Archegos Capital and Greensill Capital (UK) Ltd.

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But analysts are still pessimistic regarding future profitability.

Cyclical and structural factors continue to weigh on profits, Ratings said in its June 24 review of roughly 60 European banks. Profits in markets like the U.K. and the Netherlands will be tough to achieve for banks lacking scale or differentiated propositions, it said. Other markets have different challenges — for example, German private banks face strong competition from mutual banks.

Write-backs will only provide a "short-term boost" to the bottom line while earnings will remain "muted" by a lower-for-longer interest rate environment, amid which 2021 revenues are likely to be subdued, according to Scope Ratings' European Banking Update, published July 23.

Manageable asset quality risks

Banks have so far not seen a surge in nonperforming loans but as more government COVID-19 support measures end, analysts expect a deterioration in asset quality. This is likely to be more visible in 2022 and will happen gradually rather than suddenly since the measures will not end all at once, according to DBRS' Rivas.

But near-term downside risks have been easing, according to Ratings. Its base case is that banks will likely manage through the "inevitable rise" in bad loans even if they were to take top-up provisions, Edwards said.

The banks all have capital buffers above regulatory requirements, S&P Global Market Intelligence data shows.

NatWest, ABN AMRO Bank NV, UniCredit SpA, Lloyds, ING Groep NV, Danske Bank A/S, HSBC and Barclays held common equity Tier 1 ratios above 15% at the end of June. France's Natixis SA and Germany's Deutsche Bank AG have the smallest buffers above their regulatory minimums, of 2.9 percentage points and 2.8 percentage points, respectively.

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"[Concerns] over asset-quality cliffs are misplaced ... Most banks will be able to absorb high credit costs through pre-provision profits," Scope Ratings said. However, the agency warned of "asset-quality hotspots" that could arise due to the "asynchronous" nature of the recovery.

As for more provision releases, DBRS' Rivas said banks based in countries where economic recovery is weaker and with large stocks of legacy NPLs would be more cautious until there is more clarity on the asset quality impact of moratoria expiry.

If banks do need top-up provisions due to additional NPLs in pandemic-affected sectors, the risks would likely be against earnings rather than capital, S&P Global Ratings' Edwards said.

Banks in Russia and Ukraine, where government ownership means banks are subject to different market dynamics than those in Western Europe, were omitted from this analysis.