European Banks Asset Quality Performance

Trend in NPL Reduction Unlikely to be Sustained in 2024

DBRS Morningstar released a commentary discussing the varied asset Quality performance across European banks in 2023 and asset quality outlook for 2024. The analysis is based on data for significant institutions directly supervised by the ECB in 11 European countries covered by the rating agency

DBRS Morningstar expects that European Banks will maintain strong asset quality in their fourth-quarter reports and into 2024, despite the difficult conditions created by rising interest rates. Asset quality outcomes, however, remain inconsistent across various nations. In countries traditionally burdened with high Non-Performing Loans (NPLs) such as Spain, Italy, Portugal, Ireland, and Greece, banks have been effectively lowering their NPLs. Conversely, banks in other nations have experienced a slight increase in NPLs, starting from relatively low levels—a trend DBRS Morningstar foresees persisting into the final quarter of 2023 and through 2024.

European economic growth has shown signs of slowing, and it is still too soon to fully understand the impact of the Red Sea crisis on European inflation, the supply chain, and global trade at large. An escalation in geopolitical tensions could result in a prolonged period of high interest rates for European banks. In this increasingly difficult operational landscape, DBRS Morningstar projects a gradual decline in the asset quality of European banks in 2024. This is expected to manifest as either a quicker influx of new NPLs or a deceleration in NPL recoveries, which would reverse some of the positive trends previously noted, especially in countries that have struggled with high levels of NPLs in recent years.

DBRS Morningstar's analysis, based on data from the European Central Bank (ECB) concerning significant banking groups across 21 countries for Q3 2023, focuses on 11 European countries where DBRS Morningstar holds bank ratings. These countries account for approximately 99% of the total NPLs and 91% of the Stage 2 loans supervised by the ECB as of the end of Q3 2023.

According to the ECB's data released on January 12, 2024, the asset quality of European Banks remained resilient through the end of the third quarter of 2023. The total NPLs in DBRS Morningstar's sample amounted to EUR 341 billion at the end of Q3 2023, showing a slight decrease of 0.9% year-over-year. Notably, there was a clear distinction in NPL performance between countries with historically high NPLs, which continued to see a reduction in NPLs through effective internal workouts, sales, and write-offs.

Specifically, Greece saw the most significant reduction in NPLs during the first nine months of 2023, with a 24.7% year-over-year decrease, followed by Portugal, Ireland, Italy, and Spain. Conversely, countries traditionally exhibiting the lowest NPL ratios, such as Germany and France, experienced some increases in NPLs. Collectively, banks in high NPL countries reduced their NPLs by 10.2% year-over-year in Q3 2023, contrasting with a 6.7% increase in NPLs among banks in other countries within DBRS Morningstar's sample.

The performance of Stage 2 loans across these European banks was more varied by country and could potentially worsen in the coming quarters under increasingly challenging operating conditions. Sectors such as commercial real estate and consumer lending could face difficulties in 2024. The geopolitical uncertainties, including the Red Sea crisis, might lead to an uptick in Stage 2 loans depending on the sector, though it's premature to predict its broader economic impact.

The total Stage 2 loans in DBRS Morningstar's sample reached EUR 1,339 billion at the end of Q3 2023, marking a 5.6% year-over-year decrease. French banks reported a decline in Stage 2 loans over the year, which might relate to their reported increase in NPLs during the same period. However, there doesn't appear to be a consistent relationship between the performance of NPLs and Stage 2 loans across other countries in the sample, with some, like Ireland and Spain, seeing Stage 2 loan growth while reducing NPLs.

Despite these observations, the overall NPL and Stage 2 loan ratios among European banks have shown little change, underscoring their resilient asset quality metrics. Nonetheless, with the economic outlook for most European countries looking dimmer for 2024 and the potential for more pronounced effects from geopolitical developments, DBRS Morningstar adopts a cautious stance towards the asset quality outlook for the year. Slower economic growth typically leads to weaker credit, deteriorating asset quality, and higher provisioning needs.

Maria Rivas, Senior Vice President of Global FIG at Morningstar DBRS, pointed out that up to the end of the third quarter of 2023, the quality of assets held by European banks remained strong. She cautioned, however, that increasing geopolitical tensions could lead to a prolonged period of elevated interest rates for these banks. Rivas anticipates a gradual decline in the quality of European banks' assets in 2024, marked by an increase in Non-Performing Loans (NPLs), either due to a rise in new NPL entries or a slowdown in NPL recoveries. This would counteract some of the positive trends previously seen among European banks.

Relevant Links:

https://dbrs.morningstar.com/research/426984/asset-quality-performance-across-european-banks-trend-in-npl-reduction-unlikely-to-be-sustained-in-2024

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