Spanish banks: cost of risk manageable in 2020 but watch the shape of any recovery

Spanish banks reported a solid set of Q1 results, mostly on account of a very strong showing in January and February before the Covid-19 lockdown. Pre-provision profitability for several banks increased though reported net profits were down, driven by higher cost of risk in anticipation of the lockdown. Some banks did suffer some erosion in their capital ratios, mostly from the market rout in March and ensuing markdowns of equity and debt securities. But they remain comfortably above requirements, especially so after accounting for flexibility in P2R composition. “With dividends and buybacks now very unpopular with supervisors, our expectation is for the banks to use profits to protect their capital levels,” said Marco Troiano, deputy head of the financial institutions team at Scope Ratings and author of a report out today.

Since Q1 only reflected a couple of weeks of lockdown, there was no sign of asset-quality deterioration in reported Q1 numbers. But banks did start booking provisions – ranging from 35bp of loans at Unicaja to 141bp of loans at BBVA – in anticipation of worsening trends later in the year and reflecting higher loss-expectations under IFRS 9.

“Asset-quality trends remained positive, with sequential declines in NPL ratios and reported coverage ratios boosted by the provisioning efforts,” said Troiano. “But we believe this will change,” Troiano cautioned. Asset-quality indicators tend to lag economic reality by a few quarters. Due to the payment moratoriums and associated supervisory flexibility, the lag may be amplified, with borrowers’ credit problems not surfacing until the end of the year.

On the plus side, Scope anticipates that the banks will be able to absorb these provisions out of ordinary profitability, maintaining positive bottom lines for the rest of the year.

The size of provisions primarily reflected each bank’s business model: those with a focus on residential mortgages typically provisioned less than SME and corporate lenders. The banks clearly flagged these provisions as exceptional and disclosed separately from the underlying cost of risk, which remained under control. Bank’s own expectation for 2020 cost of risk is in the 50bp-100bp range for most banks – which Scope would consider manageable if realised.

“Spanish banks enter the crisis from a position of strength, with pre-provision profitability exceeding 1% of loans, with few exceptions. But we do see some downside to our expectations. Cost of risk estimates/guidance are based on a sharp but short recession. A second lockdown in the second half of 2020 would deepen and lengthen the recession and would likely lead to more than proportional increases in cost of risk,” Troiano said.