ISP Intesa Sanpaolo Spa

By Patricia Kowsmann and Margot Patrick 

European banks say they are doing just fine during the coronavirus pandemic. But regulators and bank executives are concerned about the elephant in the room: a wave of bad loans that could overwhelm lenders when government rescue packages end.

The economies of Europe plunged this year, and fresh lockdowns in many countries are weighing on nascent recoveries. Yet the unprecedented levels of government and financial-sector support, including repayment moratoriums sometimes covering a quarter of all outstanding loans, have kept households and companies afloat. That means banks haven't had to recognize those loans as potentially soured.

Even bank CEOs are wondering what happens when the support ends.

"What we have is a very strange crisis" in which economies are falling sharply but defaults aren't rising mostly because of the relief measures, Steven van Rijswijk, chief executive of ING Groep, said last week. "When these measures stop, what then will the picture be? We have limited visibility as of yet."

Regulators fear some European banks are too slow to react to borrowers' potential troubles ahead. The European Central Bank said bad loans in the eurozone could soar as high as EUR1.4 trillion, equivalent to $1.7 trillion, if the economies fall even more than expected, a scenario the central bank said is severe but plausible. That amount would be more than during the aftermath of the financial crisis.

The concern is that banks could run out of capital if they are suddenly overwhelmed by defaults, needing state support or even failing. What isn't clear right now is how quickly those defaults could pile up, or if state programs might cushion banks' losses for years to come.

Elke König, head of a European Union agency set up after Europe's financial crisis to handle troubled banks, said lenders need to act quickly to identify and deal with loans that are unlikely to be repaid. "There is no magic wand to make potential losses go away," Ms. König said.

European banks were already far behind U.S. rivals in recovering from that last severe shock in 2008. Then, U.S. banks got help from government programs and central banks to unload bad assets quickly, while banks in Europe became ensnared by a sovereign-debt crisis that curbed economic growth. Low interest rates, imposed to stimulate spending, further hit banks' profits.

This time around, U.S. workers who lost their jobs got weekly payments of $600 for several months, while others stayed at work because of Paycheck Protection Program loans to small businesses.

While many U.S. banks let borrowers skip some payments, overall support has been less generous than in Europe.

In Italy -- where banks are still trying to deal with old bad-debt portfolios -- over 25% of loans to businesses and 15% to households, totaling around EUR300 billion, were put under payment holidays, according to Marco Troiano, deputy head of the banks team at the ratings company Scope Ratings. The country was for a long time the epicenter of the virus outbreak in Europe and has been hurt by a collapse in tourism.

In Portugal, where companies and the government are highly indebted, loan moratoriums to businesses covered almost a third of the total, according to the country's central bank. Over half of the credit to companies in the hospitality and restaurant sectors are under the program.

"Until the moratoriums are resolved, it will be challenging to assess the real extent of losses," Mr. Troiano said.

Carlo Messina, chief executive of the Italian lender Intesa Sanpaolo, sounded upbeat in recent comments, saying that despite the pandemic his bank had the lowest-ever inflow of bad loans in the first nine months of 2020.

In Spain and elsewhere, "customers' behavior has been better than the guidance we gave in April and July," said Ana Botín, executive chairman at Banco Santander SA, a major lender in Europe and Latin America. Most borrowers restarted payments when moratorium programs expired, she said, and the ratio of nonperforming loans actually fell this year. Around EUR40 billion in loans, or 4% of Santander's loan book, is still under moratorium, including many Spanish mortgages.

According to an analysis by Spain's central bank, the heaviest users of payment holidays are households that were already more financially vulnerable. It estimates that more than EUR52 billion of household and personal business loans in Spain, or about 8% of those that qualify, is currently on hiatus.

Countries across Europe have also rolled out subsidies to companies so they could keep idled workers, preventing unemployment from shooting up. In contrast, the jobless rate had jumped in the U.S.

Part of the reason for the rosy picture from banks comes down to accounting rules. Banks can typically count a loan as performing until there is actual deterioration, such as missed interest payments or a company going bankrupt.

Andrea Enria, the head of the ECB's supervision arm, said some banks are being optimists and waiting until there is concrete evidence a customer is going bankrupt. He told European lawmakers last month that banks shouldn't let loans "rot in their balance sheets."

European banks are lending now, including more than EUR400 billion to businesses this year under government programs that guarantee a chunk of the repayment to the banks. The programs are giving companies much-needed cash to keep their businesses going, but they can also keep nonviable companies alive.

Local cinemas, family-run restaurants and hair salons are among the businesses receiving such loans, according to announcements by banks, even though it is unclear when those sectors will fully recover.

"At the moment the biggest bank is governments," said Matt Long, head of capital markets for Europe at Accenture. "When that stops, that's when we get to see the real ability of the borrowers to pay back the loans and meet their borrowing commitments."

Write to Patricia Kowsmann at patricia.kowsmann@wsj.com and Margot Patrick at margot.patrick@wsj.com

(END) Dow Jones Newswires

November 11, 2020 05:48 ET (10:48 GMT)

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