- The vulnerability exercise performed by the European Central Bank (ECB) on 86 eurozone banks concluded that, on aggregate, banks will have the capacity to cope with the ongoing COVID-19-induced recession if, by end-2022, most of the lost economic output has been recovered.
- Aggregate figures, however, mask differences; for 25% of banks in the sample, the Common Equity Tier 1 (CET1) capital ratios will fall by at least double the 1.9% average.
- Strengthened capital ratios provide a substantial buffer to absorb the hike in credit losses, but the sector would be more resilient if core profitability were stronger.
- The ECB's modeling shows that capital depletion will be much more significant in a scenario of modest, longer recovery that extends beyond 2022.
- All the above is consistent with our views and our rationale for affirming most European bank ratings in recent months while revising a substantial proportion of outlooks to negative.
- As the ECB acknowledges, downside risks to this base case are more than theoretical. An even weaker economic outturn would exacerbate asset quality weakness and subsequently rating pressure.
The ECB's vulnerability analysis, published yesterday, concluded that most banks will prove resilient against the COVID-19 pandemic--in its central macroeconomic scenario--a view that S&P Global Ratings shares. The test--a desktop exercise rather than a formal stress test--envisioned a 2020-2022 macroeconomic base case that broadly aligns with our own, with the eurozone economy rebounding post-shock and almost returning to pre-COVID-19 levels by end-2022. Profitability would be dented; the ECB forecasts the sector as a whole would be loss-making in 2020. Nevertheless, capital ratios should prove fairly resilient. On average, the ECB calculated depletion of CET1 capital at almost 2 percentage points over 2020-2022, with most of the decline concentrated in the first year. With an end-point weighted-average CET1 ratio of a healthy 12.6% in 2022, banks should continue to be able to extend credit to help secure economic recovery.
This fairly moderate effect on banks broadly aligns with our base-case expectation, and is consistent with our current position, whereby we have downgraded very few European banks so far despite the unprecedented decline in economic activity in the past quarter. The macroeconomic forecast, stronger bank balance sheets, and fulsome fiscal support are central to this relatively benign view.
However, the base case is hardly a clean bill of health. On aggregate, eurozone banks might remain relatively resilient, but there could be wide disparity across banks. The ECB in particular highlights that a quarter of eurozone banks would see their CET1 capital ratios decline by 4 percentage points--twice the average calculated for the 86 banks included in the exercise--leading to a less comfortable average CET1 ratio of 10.7%. By implication, this means that some banks will likely be well below this average.
We agree with the ECB that corporate-focused banks are likely to struggle most, and that some banks' limited earnings buffers undermine their resilience to a rise in credit losses and so to capital depletion. The ECB data suggests, for example, that small domestic retail lenders could post lower credit losses than global systemically important financial institutions and universal banks, but end up with higher capital depletion.
We share the view that one of European banks' abiding concerns--existing core profitability challenges--will be compounded by the effects of the pandemic. The ECB outlook for 2020 profits is weaker than ours, as it envisions that on aggregate, this group of banks will report €53 billion net losses. This is explained by an almost 20% decline in revenues and credit provisions more than doubling. Compared with the ECB forecasts, ours anticipate a more gradual recognition of credit losses over this year and next, rather than a big hit in 2020, resulting in a smoother effect on bottom-line results. Despite its expectation that banks would report profits again from 2021, the ECB forecasts 2022 sector profits at just 65% the level of those recorded in 2019. This highlights that bank management teams cannot afford to loosen their focus on the medium-term challenge of business and operating model sustainability; arguably, they should double-down on related initiatives.
The ECB's adverse scenario is more troubling. The assumed deeper economic downturn and slower recovery would spur a much higher spike in unemployment, resulting in corporate and personal insolvencies. In this scenario, the cumulative GDP decline over 2020-2023 is 6.3%. The ECB found that this scenario would undermine banks' asset quality and significantly drag down their capital ratios. On average, the cumulative CET1 ratio depletion by end-2022 was estimated at 5.7 percentage points, more significant in the first year, but, in contrast to the central scenario, continuing during 2021 and 2022. In this adverse case, the average CET1 ratio would stand at a more stretched 8.8% in 2022, declining to a thin 6.8% for the group of banks in the 25th weakest percentile. At this level, the weakest banks would, in our view, struggle to persuade the market that they remained viable.
In this context, the ECB has continued to urge banks to avoid unnecessary distributions. It extended the recommendation to avoid paying dividends and buying back shares to January 2021, while also specifically asking banks to carefully consider the extent of their variable remuneration, all with the aim of preserving resources. While this caution is contested by some equity investors, particularly because the approach is blanket rather than tailor-made to specific banks--we view the regulator's stance as understandable and also the approach least likely to spur a confidence crisis. On the other hand, to ease some banks' concerns and encourage them to continue channelling credit to the private sector, the ECB also clarified that the temporary relaxation of liquidity and capital requirements will not be reconsidered until at least end-2021 and end-2022 respectively.
Our negative outlooks on many European banks reflect diverse elements of downside risk, but the dominant recurring feature is the possibility of a weaker, longer path to recovery and its effect on banks' creditworthiness, particularly where there were pre-existing weaknesses. We also remain highly mindful that there could be significant divergences across European economies, and so across European banks, the vast majority of which retain a predominantly domestic focus.
If this adverse scenario plays out, the policy response will be important. It is hard to judge in advance, but we still see substantial capacity to soften the blow. In March and April, supervisors reacted quickly to cut buffer requirements, but they could choose to go further. Governments could delay the taper in their fiscal support measures, and existing government guarantee schemes often still have substantial unused drawdown capacity. Bank liquidity is unlikely to become a systemic problem because the primary market has bounced back to life, and the ECB and other central banks have shown themselves willing to do what it takes to keep this concern off the table. A pragmatic application of the state aid framework would likely facilitate direct support for banks, which could still arrive in the form of bad asset alleviation. Equity injections are well beyond our current base case. Ongoing discussions around setting up special-purpose vehicles to house problem credits could revive. As in the 2008-2010 financial crisis, the strongest banks might even be encouraged to take over weaker ones (another reason to keep them well-capitalized, even if they could be in a better position than others to distribute dividends).
In the near term, asset quality, and its effect on capitalization, will be the primary determinant of eurozone banks' fates. We expect banks' second quarter earnings to provide much stronger insights on this topic, though they are unlikely to be conclusive - fiscal support measures for corporates and households remain in force, so the full underlying effect remains obscured. We expect a full picture to emerge only from late autumn 2020.
Our ratings reflect a high degree of uncertainty about the impact of coronavirus outbreak and pace of the recovery.
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
The ECB's COVID-19 Vulnerability Analysis
- The vulnerability analysis focused on 86 significant institutions under the Single Supervisory Mechanism (SSM).
- It aimed to identify banks' potential vulnerabilities to the COVID-19-induced economic recession.
- It is based on information the ECB had available and did not involve direct engagement with banks to avoid overburdening them.
- The ECB considered the outcome fairly representative for the banking system as a whole, but not enough to publish its findings by entity.
- The results will be used to challenge banks' medium-term financial and capital plans and the severity of the assumptions undertaken to calculate provisions. They will also serve as an additional input in the Supervisory Review and Evaluation Process (SREP) assessment, but will not lead to automatic supervisory actions.
- Individual results will not necessarily be discussed with all banks.
- Two macro-economic scenarios considered:
- --A central one, which reflects the ECB's base-case projections published in June 2020.
- --A severe, but plausible scenario that contemplates a harsher contraction in 2020 and feeble, longer recovery afterwards.
- The scenarios assume a deeper economic recession in 2020 than that of the 2008-2009 global financial crisis, but a less protracted downturn.
- For reference, the ECB also published its pre-COVID-19 base-case expectations defined in the 2020 European Banking Authority (EBA) EU-wide stress test.
- Static balance sheet.
- Support measures largely taken into account into the macro-scenarios and bank-specific calculations with the exception of moratoria schemes.
- Government guarantees: assumed a 51% take-up rate, usage of €700 billion of government-guarantees to cushion credit risk. States to absorb €21 billion of credit costs under the central scenario and €42 billion under the adverse one. No benefit in the calculation of risk-weighted assets contemplated, however.
- Benefit of cheaper TLTRO (targeted longer-term refinancing operations) III funding not incorporated in banks' profitability forecasts.
- Mitigating management actions not contemplated.
The ECB's COVID-19 Vulnerability Analysis - Part II
- Central scenario: Average CET1 capital depletion of 1.9 percentage points (pps), with average CET1 moving to 12.6% in 2022 from 14.5% in 2019.
- Adverse scenario: Average CET1 capital depletion increases to 5.7 pps, with the average CET1 declining to 8.8% by 2022, again from 14.5% in 2019.
- Credit risk is the key driver of capital depletion in both.
- Dispersion of capital resilience increases the more negative the scenarios become.
- Average capital depletion for banks in the weakest 25th percentile of 4 pps and 8.5 pps, respectively in the central and adverse scenarios. Average CET1 for the group falling to 10.7% and 6.8% in 2022 in the central and adverse scenarios, respectively, from 13.6% in 2019.
- Diversified banks (31 of the 86 banks) show the highest capital depletion in the adverse scenario; G-BIS and universal banks (20) the lowest, thanks to higher-than-average earnings.
- Corporate-focused and sectoral lenders (17) report the highest capital depletion in the central scenario, but not in the adverse.
- Corporate and consumer lending drive the majority of credit impairments. Cumulative credit losses over a three-year period for corporate loans were estimated at 1.43% in the central scenario, 2.89% in the severe. Cumulative credit losses for consumer loans at 3.94% and 7.14%, respectively. For comparison purposes, the cumulative losses assumed by the Bank of England (BoE) in its latest stress test from May 2020 for these two asset classes were harsher: 6.5% for corporate loans and 15.5% for consumer loans (and potentially more considering the BoE only covered two, rather than three years). The macroeconomic scenario was also more severe, envisioning a 14% GDP contraction in 2020.
- On aggregate, the 86 banks included in the exercise will post €53 billion of losses in 2020, down from €67 billion in 2019. Profitability will bounce back to €39 billion in 2021 and €43 billion in 2022.
- EMEA Financial Institutions Monitor 3Q2020: Low Profitability Lingers On, July 24 ,2020
- Global Banks Outlook Midyear 2020: A Series Of Reports Look At The Profound Implications Of The COVID-19 Shock, July 9, 2020
- ECB Set To Ease Regulatory Hurdles To Eurozone Bank Consolidation, July 3, 2020
- Asset Quality Not ECB Liquidity Will Determine Eurozone Banks' Fates, July 2, 2020
- Credit Conditions Europe: Curve Flattens, Recovery Unlocks, June 30, 2020
- Economic Research: Eurozone Economy: The Balancing Act To Recovery, June 25, 2020
- COVID-19: Swiss Banking Sector To Remain Resilient, June 17, 2020
- COVID-19: Resilient Fundamentals And Assertive Policy Measures Will Buoy Nordic Banking Systems, June 16, 2020
- How COVID-19 Is Affecting Bank Ratings: June 2020 Update, June 11, 2020
- Bank Regulatory Buffers Face Their First Usability Test, June 11, 2020
- The European Crisis Backstop Is Underpinning Corporate Funding Conditions, May 19, 2020
- How COVID-19 Risks Prompted European Bank Rating Actions, April 29, 2020
- Europe’s AT1 Market Faces The COVID-19 Test: Bend, Not Break, April 22, 2020
- COVID-19 Countermeasures May Contain Damage To Europe's Financial Institutions For Now, March 13, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||Elena Iparraguirre, Madrid (34) 91-389-6963;
|Secondary Contact:||Giles Edwards, London (44) 20-7176-7014;
|Research Contributor:||Marta Heras, Madrid (34) 91-389-6967;
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.
Any Passwords/user IDs issued by S&P to users are single user-dedicated and may ONLY be used by the individual to whom they have been assigned. No sharing of passwords/user IDs and no simultaneous access via the same password/user ID is permitted. To reprint, translate, or use the data or information other than as provided herein, contact S&P Global Ratings, Client Services, 55 Water Street, New York, NY 10041; (1) 212-438-7280 or by e-mail to: email@example.com.