Portfolio Lead Advisory Services Weekly Digest - Edition 19

German credit markets

The Deutsche Bundesbank recently announced that the German financial system has proven to be stable and has fulfilled its key function during the pandemic. However, expectations are that insolvencies in the corporate sector will increase going into next year and will require banks to be more financially and operationally prepared.

Due to the extensive government support earlier in the year, the impact of the crisis has not yet resulted in a significant increase in corporate insolvencies – also due to the fact that there is a temporary suspension of bankruptcy-declaration requirements.

However, that could all change early next year with the Bundesbank simulations predicting that insolvencies and value adjustments will increase, with some 6,000 insolvencies per quarter in the first quarters of next year, compared with 4,700 in total for 2020.

The Bundesbank stressed that it is crucial for banks to be selective in risk undertaking by “distinguishing good risks from bad” and also to continue lending and “…grant loans to good borrowers." In the event bankruptcies and loan defaults increase unexpectedly, without further government liquidity support, banks may rein in their lending to comply with financial and regulatory requirements which would further slow the economic recovery or exacerbate an economic slump.

Bank de-leveraging initiatives

With the softening of economic forecasts for Germany as well as tightening of liquidity markets, banking and financial institutions will likely be required to accelerate the review of their portfolios to identify non-core assets and pursue deleveraging strategies to preserve the robustness of their balance sheets, creating capital buffers in anticipation of a challenging operational environment.

A number of banks have already published their intentions in relation to this – Deutsche Bank have said their plan to offload most of the assets that were transferred to their bad bank by 2022 is on track despite current market conditions. Hamburg Commercial Bank, which underwent privatisation in 2018, have reported a regulatory Common Equity Tier 1 (CET1) capital ratio above 20% in Q2 this year, driven primarily by its ongoing deleveraging initiatives in combination with selective new business activity. German Landesbanken (federal state banks – BayernLB, NordLB, LBBW, HeLaBa) have reported good asset quality and capital levels. However, given concentration in commercial real estate as well as aviation finance on their balance sheets, this presents uncertain credit risks going forward if the pandemic persists – some of these banks have thus announced plans to increasingly manage credit risks through syndications, risk participations and/or securitisation strategies – a trend we expect to continue going into Q1 of next year.

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