As an update to our last IFRS 9 results blog, 2020 Year End Results in 10 Charts, published in March, this post gives a 1Q21 update on the loss reserving trends and outlook for UK banks. As before, we have analysed the aggregate position of Barclays, HSBC, Lloyds, NatWest and Santander UK as a proxy for the wider UK banking sector.
4Q20 was broadly stable on the preceding two quarters: flat balances, flat ECL, flat coverage, and flat Stage 3 with no emergence of credit risk. However, the economic outlook had been brightening and payment holidays had largely run off with the overwhelming majority of customers performing on exit.
The first quarter of 2021 has seen firms reflect that improved outlook through provision releases (or very low charges), reductions in ECL balance, and consequent reductions in ECL coverage (i.e. ECL/assets). But the credit risk is still latent, supported by government intervention, with benign credit performance and low flow to default.
This may signal the beginning of the end for COVID-19 and IFRS 9 and the start of a wider release of provisions as firms become more confident about the improved outlook. However, caution is likely to remain the watchword - the releases so far are relatively small (c. £3bn or 7% lower than 4Q20) and firms are likely to be reluctant to release provision only to have to build reserves again should circumstances change. This leaves ECL balances c. £10bn above pre-crisis levels suggesting that banks still expect a significant level of credit loss (c. 45bp of loan balances).
1) 1Q21 saw a £0.7bn P&L release and negative cost of risk compared to the significant build of reserves in 1Q20 and 2Q20
2) Mirroring the P&L position, ECL balance and coverage both reduced by c. 7% in 1Q21 reflecting benign performance and the improved forward view of risk
3) The credit environment has continued to be benign with the extension of government support stemming flows to default and keeping Stage 3 credit impaired balances broadly stable at 1.9% of loans and advances
4) Stage 2 balances have reduced due to a combination of benign observed credit performance and the improvement in outlook giving better forward-looking default expectations (meaning that fewer accounts are expected to experience a Significant Deterioration in Credit Risk which would trigger Stage 2 classification)
The tone from each of the banks is optimistic but cautious, with some firms explicitly calling out improvements in outcome for 2021:
“Barclays expects that the full year 2021 impairment charge will be materially below that of 2020 reflecting delinquency experience and an improved economic outlook during the latter part of Q121. If these conditions persist, Barclays would expect to reduce the impairment provision level.”
“Our 1Q21 results were favourably impacted by net ECL releases, particularly in the UK, reflecting improved economic forecasts. There remains a high degree of uncertainty as countries emerge from the pandemic at different speeds and as government support measures unwind. Based on the current consensus economic forecasts trajectory, we expect our ECL charge for 2021 to be below the medium-term range of 30bps to 40bps of average loans that we indicated at our 2020 annual results.”
“Given the benefit recognised in the first quarter of the year, the full year charge is now expected to be materially lower than the guidance set out at year-end. Based on the Group's improved economic assumptions, the net asset quality ratio for 2021 is now expected to be below 25 basis points.”
No change since YE20: “We expect FY’21 impairments to be at or below our through the cycle range of 30-40bps of gross customer loans.”
“Although the economic outlook is more positive, market conditions will remain uncertain given the low interest rate environment and the lasting impacts of the pandemic.”
Firms remain concerned about the high level of uncertainty in the economic outlook and the potential cliff-edge credit risks when state support is phased out – in the UK in February 2021 just under five million employments were furloughed, not all of which will be viable post-crisis (this compares to c. 32 million people in employment and under two million unemployed).
From a risk measurement point of view, firms will have to consider the likely uneven nature of the recovery: for personal lending the impact of the crisis has been much harder on younger, lower income demographics; for corporates the sectoral outcome will be uneven and identifying “zombie” companies may be difficult. And there is still a significant level of judgement and management intervention in the loan loss reserving process that we consider will continue for some time.
With regard to what will happen with IFRS 9 at 2Q20, interesting topics to watch over the next quarter will be: the start of payments (and subsequent credit performance) of government-backed lending; the evolution of the 1Q21 trends of strength in mortgage lending, weakness in consumer lending, and subdued corporate lending; and the news flow around the risks/threats to the economic recovery as lockdown measures are (hopefully) progressively lifted.