30 July 2020
The European Banking Authority (EBA) published today its quarterly Risk Dashboard together with the results of the Risk Assessment Questionnaire (RAQ). The updated data shows that the impact of COVID-19 was mainly reflected in a contraction of banks’ capital ratios and profitability, the cost of risk increased, whereas non-performing loans (NPL) ratios remained stable, confirming that the impact of the pandemic on asset quality can be delayed. The EBA also published a thematic note on leveraged finance, which highlights that the expansion of this market segment in recent years has come along with a significant easing of credit standards.
The average CET1 ratio fell to 14.6%, which is 40bps down compared to EU27 pro forma data for Q4 2019. The contraction was driven by a 1.8% increase in risk-weighted assets (RWAs) and a 1.4% decline in capital. The latter was mainly due to a reduction in the other comprehensive income (OCI) reserve as a result of valuation effects. The increase in RWAs was largely due to a rise in its credit risk component, not least supported by an increase in loans and advances, in particular those to non-financial corporates (+3% quarter over quarter [QoQ]). Loans to households fell by 1.3%.
Banks’ average return on equity (RoE) decreased to 1.3% (5.9% for EU27 pro forma data in Q4 2019). Total net operating income dropped by 5.4%, not least driven by a contraction in net trading income, and operating expenses increased by 5.2% QoQ. This resulted in a rise of the cost to income ratio to 71.7% (64.4% for EU27 pro forma data in Q4 2019), which is the highest value for years. According to the RAQ results, the outlook is similarly bleak, with nearly half of the banks not expecting any improvement in their profitability in the next 6 to 12 months, despite the already subdued RoE level.
Costs of risk grew significantly from 50bps to 81bps on an annualised basis, showing a rising dispersion among banks. It came in parallel to a rise in stage 2 loans (from 6.5% for EU27 pro forma data in Q4 2019 to 7%) and in banks’ coverage ratio of NPLs (from 45.8% for EU27 pro forma data in Q4 2019 to 46%).
The non-performing loan (NPL) ratio remained broadly unchanged, at 3% in Q1 2020, slightly down from 3.1% for EU27 pro forma data in Q4. On a segment level, the NPL ratio for non-financial corporates (NFC) exposures was 5.1%, with CRE and SME loans at 7.6% (down from 7.7%) and 7.7% (down from 7.9%; all for EU27 pro forma data in Q4 2019), respectively. For mortgage loans, the NPL ratio was stable at 2.8%. The RAQ results show a substantial increase of banks’ responses pointing to a deterioration in asset quality. This holds for all asset classes, with around 60% of banks expecting a worsening in the asset quality of SMEs followed by corporate, consumer credit and CRE (around 50% of the banks).
Banks’ liquidity positions did not show any deterioration in Q1 2020. Despite the increase in drawings of credit lines and market tensions, the liquidity coverage ratio (LCR) remained roughly stable at 148.9% (148.2% for EU27 pro forma data in Q4 2019). The massive use of central bank funding, for which collateral needs to be provided, has brought up the asset encumbrance ratio to 26.7% (25% for EU27 pro forma data in Q4 2019). Focusing on the next 12 months, banks intend to attain mainly more senior non-preferred and senior holding company (HoldCo) debt (both as one single category in the survey) and senior unsecured (around 40% of respondents for both categories), according to the RAQ results.
The note highlights that borrowers’ indebtedness has risen materially while loan maintenance covenants have been relaxed. These vulnerabilities and the inherent risks of leveraged finance led to a sharp contraction in the market during the COVID-19 outbreak.
For a sample of 26 large EU/EEA banks, the overall exposure to leveraged finance amounts to EUR 400bn (2.5% of their total assets), concentrated in a few large and highly interconnected institutions. The main exposure is through leveraged loans while exposures to high yield bonds and CLOs are comparatively small. Banks might also be directly or indirectly exposed to leveraged finance investors to which they provide credit lines or prime brokerage services or to which they have legal or reputational ties.
The figures included in the Risk Dashboard are based on a sample of 147 banks, covering more than 80% of the EU/EEA banking sector (by total assets), at the highest level of consolidation, while country aggregates also include large subsidiaries (the list of banks can be found here). The figures related to the Risk Dashboard refer to the EU27 for Q1 2020 and are compared, where appropriate, to EU27 pro forma data for Q4 2019.
The results of the RAQ are significantly influenced by the timing of submission of the responses. In particular, some of the respondents prepared their answers at the beginning of the outbreak of COVID-19 in Europe, while others responded at a time when the outbreak was rapidly spreading across Europe. As a result, some banks already partially considered the impact of the pandemic in their responses, whereas others did not.