Outlook 2021/2022: The impact of payment moratoria and public loan guarantees
The depth of the coming non-performing loan (NPL) cycle throughout the euro area will, to a significant extent, be aligned to the moratoria on loan repayments and public gloan guarantees.
The moratoria and guarantees attenuated the immediate impact of the abrupt freeze in economic activity, supported new lending and provided necessary breathing space to borrowers. But these policies have disguised underlying weak corporate trading and simply delayed credit losses and, ultimately, NPLs. Higher corporate default rates and unemployment across the EU are inevitable in the coming months, which in turn will impact household solvency. According to the European Central Bank’s (ECB) adverse scenario analysis, the potential impact of the pandemic on euro area banks’ balance sheets could prompt NPLs to soar to around €1.4 trillion.
The European Banking Authority (EBA) recently published its first assessment of loan repayment moratoria and public loan guarantees on the EU banking sector. According to it, EU banks granted around €871 billion moratoria on loan repayments, as of June 2020. Of the lendings affected by this measure, 16% were SME loans, 12% were commercial real estate (CRE) loans, and 7% were residential mortgage loans, according to a first assessment by the European Banking Authority (EBA) as of June 2020. Moratoria on loan repayments varied widely between countries and banks. French, Spanish and Italian banks reported the highest volumes of loans subject to moratoria, while Cypriot, Hungarian and Portuguese banks reported the highest share of loans subject to moratoria. Around 85% of the loans under moratoria were due to expire before December 2020. However, some nations announced automatic extensions due to the second wave of Covid-19.
Public guarantees were used to a lesser extent. Around €181 billion in loans secured by public loan guarantees were extended across the EU as of June 2020, with 95% granted to non-financial corporations (NFCs). The largest public loan guarantees issuing nations were Spain, France, Italy and Portugal, respectively. In contrast to those of loans under moratoria, public loan guarantees maturities are longer. Around 44% of loans had maturities between two and five years, while another 34% of loans matured in six months to one year .
How will all this translate into the outlook for NPLs next year and beyond?
PricewaterhouseCoopers (PwC) has forecast Europe-wide NPL volume sales of around €50 billion in 2020, followed by €50 billion in 2021 and by up to €100 billion annually in both 2022 and 2023. Loans already in distress, likely single corporate loans, will come to market first followed by Covid-era small NPL portfolios by the end of Q2. More extensive NPL portfolios will emerge by the end of 2021. Crucially, this coming NPL cycle will be dominated by corporate SME loans, with the early tranche likely consisting of loans already stressed, and distressed, before the onset of the pandemic, and the Covid-era loans following after that.
Furthermore, the Covid-era loans will not be secured by specific collateral; therefore, there will be less opportunity to enforce claims against overleveraged real estate, which characterised the previous NPL cycle almost a decade ago. It will be an SME-led cycle requiring more significant turnaround and restructuring expertise. Private capital will need to work with SMEs to restructure and revive existing business and return revenues to pre-Covid sustainable levels.
In respect of countries, Northern European and Spanish banks will likely begin the clean-up first again, followed by the remainder of Southern, Central and Eastern Europe, according to PricewaterhouseCoopers (PwC). The sectors most impacted by Covid-19 include retail and hospitality, aviation, leisure as well as supply chains related to the auto and equipment industries, according to S&P Global.
Overall, the analysis empirically reinforces what the market already suspected. First, the full impact of the Covid-19 pandemic on the EU banking sector and the broader economy is yet to be determined. Banks, regulators and policymakers must remain vigilant of the cliff-edge risks on loan exposures related to the unwinding of loan repayment moratoria and public loan guarantees.
Second, the duration of the second wave of Covid-19 throughout Europe imposes downside risks to current NPL forecasts for 2021 and beyond. In part, this is due to higher volumes of lending to corporates, implying additional credit risk exposures, especially for banks in countries with a high legacy stock of corporate NPLs. Third, banks are unevenly exposed – between and within EU member states – to the cliff-edge effects of the expiry of loans under moratoria or backed by public loan guarantees. Fourth, additional measures – by regulators, central banks and national governments – may be needed to curb the danger of future adverse scenarios playing out.
This analysis is also a reminder of the vital role of information and data transparency – from individual banks’ loan exposures to a macro assessment of the state of the overall sector. The timely flow of information, with and between banks, clients, peers and regulators, is a potent tool to support assessment, mitigation and prevention of identified risks.
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