In Barclays’ 123-year history, the UK bank has never faced the prospect of so many bad loans at once.
As the coronavirus lockdown wreaks havoc on global economies, one figure will take center stage when UK and European banks start reporting their first quarter results this week: loan loss provisions.
Investors expect these charges to reach and even exceed levels not seen since the financial crisis, putting pressure on lenders’ already fragile business models.
Analysts have estimated that loan loss provisions could quadruple or more in the first three months of the year, while bank profits could fall by 50% on average for all of 2020. Worryingly, they warned that the worst was yet to come.
“The number of headlines will dominate, and with good reason,” said Jonathan Pierce, analyst at Numis. For UK banks, £ 1bn to £ 1.5bn for each bank on top of normal Q1 charges was ‘not out of the question’.
At Barclays, which recorded £ 448million in impairment charges over the same period last year, “the charges we assume this year are double those seen since its incorporation in 1896,” he said. -he adds.
The pressure is compounded by new dynamics – “forecasting arrangements will be nothing more than guesswork,” Pierce said. This reflects both the unprecedented nature of the health crisis – with the duration of the lockdowns still unknown – and the way in which the new accounting rules which force banks to recognize possible depreciations much earlier than in the past will be implemented. .
Economists are already predicting economic fallout that will be the worst since the 1930s. Meanwhile, regulators, fearing that banks will suffer losses so severe that they restrict their lending capacity, are urging policymakers to moderate estimates until. to make all the repercussions clearer.
A leading indicator can be seen on Wall Street. The six largest U.S. lenders increased their loan provisions in the first quarter by $ 25.4 billion, a 350% year-over-year increase, mainly due to potential write-downs on their credit cards and loan portfolios. commercial.
However, few expect European banks to be as conservative as their American rivals, in part because they are not profitable enough to shoulder all the potential losses out of hand.
“In general, the United States tends to be faster to take losses than the Europeans,” said Philippe Bodereau, portfolio manager at Pimco. “They pay off bad debts much more aggressively and have more effective bankruptcy rules. In Europe, they tend to smooth out losses over a much longer period.
Stuart Graham, founder of Autonomous Research, said: “European banks will not show a similar large increase. . .[because]regulatory messages encourage banks to go beyond the trigger.
Mr Graham estimated that bad debt provisions could wipe out an additional € 25 billion from the € 65 billion forecasted profits of euro area banks for 2020. He made a key caveat: “Too many of our conversations involve the phrase “no one has a clue” yet. “
Already in Europe, UniCredit – Italy’s largest bank, the eurozone’s most fragile banking market – has announced it will set aside a 900 million additional euros to cover potential loan losses. Credit Suisse said last week that provisions for the first quarter jumped 600% year on year. On Sunday evening, Deutsche Bank announced that it had taken 500 million euros in provisions for credit losses in the first quarter, compared to 140 million euros 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 ultra-low interest rates weighed on their returns, while Wall Street rivals continued to steal market share from investment banking. All this means that the cushion for absorbing a large peak in impairments is modest.
Yet most investors believe that banks will be able to withstand the fallout from the coronavirus better than they did during the 2008 financial crisis. On average, banks’ capital requirements are now 10 times higher and they are less active in risky trading activities. They also did not participate in the kind of “credit rampage” that preceded the last crisis, an investor said.
However, the crisis is expected to further deteriorate their already poor incomes. UBS has cut its earnings forecast for the UK banking sector by a third this year and nearly a fifth in 2021. So far, the benchmark European bank stocks have plunged 42% this year and the UK equivalent is down 40%.
Deutsche Bank – which at its nadir in mid-march was trading at just 0.16 times the book value of its net assets – now worth around 12 billion euros. The increasingly popular Zoom video conferencing company is valued at $ 50 billion.
The coronavirus will have a disproportionate effect on banks with business models focused on retail and commerce. These lenders have high fixed costs to run hundreds of physical branches, thousands of local employees, and earn most of their income from interest charges, a leading European banker said.
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“Their margins are collapsing as interest rates fall, but their costs remain the same, while provisions for non-performing loans soar,” he added.
Investor concerns have focused on unsecured retail loans – credit cards, personal loans and auto finance – which, in the Bank of England’s latest stress tests, had a five-year cumulative loss rate of 25%. Barclays and Lloyds in the UK are particularly at risk.
For European banks that still have significant market divisions, there may be some bright spots. Hedge funds and ultra-rich clients scrambling to reposition themselves amid the market turmoil have been a boon to trading desks: On Wall Street, income from bond and stock trading has jumped nearly ‘one third in the first trimester.
But these are only small graces for what one investor has described as “a sector without friends for many years”. The investor added: “Bank stock prices were stressed before Covid and are now very struggling. It’s not like there is a lot of hope.