As 2020 draws to a close, few could have imagined the extraordinary events of this year driven by the COVID-19 pandemic. Market volatility has been extreme, with global stock markets collapsing in the early part of the year only to rebound to record highs by year-end. Government support, fiscal stimulus, and monetary easing have been unprecedented, most recently highlighted by the European Union recovery fund signed-off this month. Economic contraction has nevertheless been sharp, on the back of the cycle of lock-downs, with the global economy suffering an over -4% contraction in 2020 according to the IMF, and only China registering positive growth amongst the world’s major economies.
Despite massive economic uncertainty, the banking industry entered 2020 in a much more robust position than the global financial crisis. High capital levels and solid liquidity have supported banks through the current turmoil, with government support measures – both with respect to liquidity and borrower forbearance – providing further protection. Extensive measures adopted by regulators (such as the ECB’s temporary relief for capital and liquidity requirements) have reduced COVID-19 related pressure, making banks the engine of recovery rather than the source of crisis over 10 years ago. Nevertheless, low to negative rates, uncertain volumes, and negative credit migration mean that financial performance is set to remain under pressure for the foreseeable future, with increased M&A activity and restructurings already underway.
Notwithstanding relative balance sheet strength, fiscal stimulus, and monetary support, the rating agencies have taken a negative view on financial institutions’ creditworthiness, with S&P reporting 240 ratings actions on banks as of November 2020 - 76% of which were outlook revisions to negative and 23% were downgrades. Fitch’s rating actions have been even more tilted to the downside, with over 500 rating actions taken between March and June 2020. As government forbearance schemes are eased off, further rating actions are likely as outperformers and underperformers from the current crisis are more clearly identified.
Additionally, whilst debt moratoria policies have mitigated any sudden recognition of credit losses, these same measures have arguably masked the true extent of the crisis. The EBA’s Risk Dashboard combined with Deloitte analysis has shown that European banks have continued to set aside substantial provisions throughout the year. Moreover, with recent lockdown restrictions expected to fuel further economic difficulties, additional provisions are expected both in Q4 and well into 2021 as the true impact becomes clearer. Indeed, there is an increasing expectation that final clarity on the scale of the ultimate loan losses caused by the COVID-19 disruption will not be seen until the second half of 2021.
In the initial months of the crisis, deleveraging activity slowed as uncertainty permeated the market. However, we are beginning to see NPL transactions pick-up again as on-hold processes began to restart and the pipeline of new deals started to increase. Activity in Europe has been particularly notable in Italy and Greece, where NPL securitisations have been assisted by Government-backed schemes GACS and HAPS. Combined with recent amendments to NPL capital treatments by BIS, the EBA and the ECB, plus persistent rumours of an EU-wide bad bank, regulators are equally working to alleviate the predicted negative credit migration in banks’ balance sheets.
Within this context, investors in distressed loan portfolios continue to see opportunities in the NPL space (including debt purchasers and loan servicers) and are aiding banks in improving their asset quality via deleveraging programs. Furthermore, European regulators have reiterated the need for banks to consolidate across borders and drive diversification to better compete internationally, particularly with the profitability of their US peers. Already transactions have been prepared across Italy and Spain, and may usher in a wave of consolidation in the new year.
With ongoing economic and market uncertainty, geopolitical tensions, and structural change in the global political and financial landscape, 2021 is set to be another defining year for the global banking sector. Join us for our first edition of the new year, where we will be exploring these and other defining issues for the market over the next 12 months.
We hope that you have found our Weekly Digest informative since our mid-year kick-off, and we look forward to providing you with coverage and insights on the latest market developments going forward.
In the meantime, we hope that you have a wonderful holiday season, and all the very best.
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