A portion of Barclays Capital’s 351-page European bank bonanza published on Tuesday, discusses the possibility of a “credit quality surprise” in 2010. That is, a decline in the number of non-performing loans (NPL), and subsequently, impairment charges taken by the region’s banks.
As the analysts, led by Simon Samuels and Mike Harrison, put it:
Reviewing the Q309 [European bank] results transcripts, the almost uniform view of management is that credit costs will “plateau” at these elevated levels. Yet that rarely happens. Since 1980 the average change each year in impairments provisions is +/-50% so “plateauing” is – at least statistically – unlikely.
So if 2010 doesn’t see impairments “plateau”, do they go up or down from here? Most of the early signs indicate a move down is more likely. Whilst non-performing loans (NPLs) are still rising, the pace of new formation has slowed sharply, from €35bn in Q209 down to €15bn in Q309. Driving this are signs of stabilisation in asset prices and a slowdown in the pace of increase in unemployment across Europe. Things are still getting worse, but at a noticeably slower pace. It is not clear if we are at a turning point, but we appear to be moving towards one.
But, when that turning point does eventually come, BarCap says, it will probably happen very quickly:
One thing that our analysis does make clear, however, is that when credit quality does finally start to improve, it rarely improves slowly. Analysing all recessions for all European banks since 1980 shows that – on average – one year after impairment losses have peaked they have fallen 45% and after two years they are down over 60%. If 2010 and 2011 were such “snap back” years, then the sector upgrade would be 80% and 20% respectively.
You can see this rather dramatic `snap back’ you can see in the below charts. The first shows impairment charges for Swedish banks, which peaked during the Swedish Banking Crisis in 1992 at circa 6 per cent, but then fell within two years to just 2 per cent. Within four years they were back down to pre-crisis levels.
The second, is from BarCap’s head of asset allocation, Tim Bond, who’s developed a predictive model for the US credit cycle (where, apparently, there’s more data available). It also forecasts a rather sharp snapback in terms of impairment charges for US banks post the current financial crisis:
So in sum, BarCap sees “a growing possibility that credit costs start to fall in 2010″. It’s also assessed the potential for such impairment reversals happening at European banks, identifying five that are “likely” or “might” see such a snapback. You can view the results here.
But, we should note, BarCap’s whole thesis comes with a rather large caveat:
However, risks remain; the IMF believes that European banks have been slow to recognise losses, residential asset prices in Europe remain very expensive relative to the (now corrected) US market and European banks – especially Swedish, Greek and Austrian – have meaningful exposure to several “Very High Risk” countries identified by the Bank for International Settlements (BIS). So whilst we recognise the potential for impairment losses to come down more than forecast, we also remain mindful of the potential for unexpected shocks. Ultimately, much will depend on the economic environment in 2010, but if economic surprises remain on the upside, so impairments could surprise on the downside, possibly meaningfully.
Related links:
BarCap calculates the cost of “Too Big Too Fail” – FT Alphaville
Banks’ coverage ratio capers, cont. – FT Alphaville
Spanish banking crises, then and now – FT Alphaville
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