European banks: IFRS 9 impact on BankFocus Research 17 June 2019 bank financials is manageable Irakli Pipia Xian (Peter) Li Leading European banks1 absorbed anticipated negative impact from the adoption of IFRS 9 without significant impact on their financials. In fact, asset quality and total provisioning coverage ratios improved across the board, despite contrary expectations. The negative impact from the adoption of IFRS 9 on regulatory CET 1 capital was most prominent for Spanish and Italian banks, but manageable for other European entities. • European banks adopted IFRS 9 accounting standards on 1 Impaired loans / Gross customer January 2018 which requires earlier recognition of credit loans & advances, YE 2018 vs losses compared to the existing IAS 39 accounting standards. YE 2017 (%) • Impaired loan (Stage 3) ratios improved under IFRS 9 compared to the same category as per IAS 39 standards for Company Name 2018 2017 Change almost all surveyed European banks (see exhibit). UniCredit 8.1 11.1 -3.0 Bankia 6.3 8.8 -2.5 • Consequently, the total provisioning coverage of impaired Caixa 4.8 6.2 -1.4 loans improved, while specific provisioning (Stage 3 Expected Sabadell 4.4 5.4 -1.0 Credit Losses vs Stage 3 loans) at 45% remains adequate as KBC 4.4 6.3 -1.9 at end-2018. BNP 4.3 5.0 -0.7 • Contrary to the original expectations, Loan loss reserves as BBVA 4.2 5.0 -0.8 percentage of Gross loans declined under IFRS 9, with the Intesa Sanpaolo 4.2 12.9 -8.7 accounting impact absorbed by banks’ regulatory capital. Santander 3.7 4.2 -0.5 • The selected European banks benefited from declining BPCE 3.2 3.5 -0.3 impairment charges as a percentage of their Operating Credit Agricole 2.6 3.1 -0.5 profits suggests improving asset quality trends during 2018. ABN AMRO 2.2 2.5 -0.3 However, this did not translate in enhanced retention of net Nordea 1.5 1.9 -0.4 profits. La Banque Postale 1.5 1.4 0.1 • On average, the absolute value of the regulatory CET 1 Commerzbank 1.4 2.5 -1.1 capital declined by 2% in 2018. However, this average is HSBC 1.3 1.6 -0.3 influenced by the negative impact from Italian and Spanish Lloyds 1.3 1.7 -0.4 banks, while the capital of other peers shows or remained flat. Handelsbanken 0.4 0.4 0.0 • Overall, poor capital generation was due to a broader issue of low profitability of the European banks with limited contribution from IFRS 9 related deductions. • This view is supported by a declining trend in non-regulatory This report has been created using capitalisation ratios (Total equity / Total assets) for the same the data of Moody’s Analytics set of banks during 2018. BankFocus. If you would like more information on how to replicate the research, or would like a free trial, email [email protected] bvdinfo.com 1 For the peer group list refer to “Research methodology and scope” on pg. 11 1 Moody’s Analytics BankFocus Research Moody’s Analytics BankFocus Research 17 June 2019 Modest growth in Total assets The aim of this research is to analyse the impact of IFRS 9 accounting standards on European banks’ asset quality, provisioning and capitalisation ratios. European banks adopted IFRS 9 accounting standards on 1 January 2018 which requires earlier recognition of credit losses compared to the existing IAS 39 accounting standards. Prior to the adoption of IFRS 9 standards market participants expected significant impact on CET 1 capital, higher provisioning expenses and broadly similar impaired loan ratios. To test these hypotheses we selected a sample of 18 leading European banks with end-2018 annual financial statements prepared in accordance with IFRS 9 accounting guidelines. We compared these with similar metrics as per end-2017 financial statements prepared under IAS 39 standards. As a starting point, we looked at asset growth rates during the last year. The growth rates of the European banks were broadly flat during 2018, with the same number of entities (nine banks) growing their assets compared to the ones contracting (nine banks). On average the annual growth of Total assets for the 18 European banks was very low, less than 1% during the last year. These modest growth trends were in line with the cautions approach to lending and risk-taking which has prevailed following the financial crisis in European banking systems. The introduction of IFRS 9 standards on its own had no visible impact on a broad growth strategy of European banks. In our view, the general appetite of the European banks to grow their balance sheets remains limited, constrained by macroeconomic concerns and the ultra-low interest rate environment. Exhibit 1: Total assets, YE 2018 vs. YE 2017 (€ billion) HSBC BNP Credit Agricole Santander BPCE Lloyds UniCredit Intesa Sanpaolo BBVA Nordea Commerzbank Caixa ABN AMRO Handelsbanken KBC La Banque Postale Sabadell Bankia € billion 0 500 1000 1500 2000 2500 2018 2017 2 Moody’s Analytics BankFocus Research 17 June 2019 Risk profile of European banks has marginally worsened We also compared the annual growth rate of Risk-weighted assets (RWAs) for the same set of banks. Here, a larger majority of banks (11 entities) recorded modest growth in RWA compared to contraction in RWAs (seven banks). The average annual growth rate of RWAs for the 18 European banks was above 3% during 2018. This was higher than the flat growth rate of Total assets for the same period. This comparison of RWA and Total asset growth rates suggests that the European banks asset risk has marginally increased during 2018. This, in our view, is due to a general strategy adopted by the European banks to compensate their low profitability by increasing the risk profile of their assets. Exhibit 2: RWA, YE 2018 vs. YE 2017 (€ billion) HSBC BNP Santander Credit Agricole BPCE UniCredit BBVA Intesa Sanpaolo Lloyds Commerzbank Nordea Caixa ABN AMRO KBC Bankia Sabadell La Banque Postale Handelsbanken € billion 0 200 400 600 800 2018 2017 Asset quality ratios of European banks have improved under IFRS 9 Despite the increase in RWAs and stagnating lending, the asset quality ratios of European banks have improved across the board in 2018. This suggests that the stock of impaired loans, which is equivalent to Stage 32 loans under IFRS 9, has declined compared to the same category as per IAS 39 standards. This trend has been helped by a benign economic environment in Europe as well as active workouts that the European banks pursued during the last year. In particular, the Italian banks Intesa and Unicredit were ahead of their peer in terms of positive year-on-year change in impaired loan ratios at 8.7% and 3%, respectively. 2 Stage 3 loans (problem loans): Impairment on these loans is recognised on the basis of lifetime expected credit losses 3 Moody’s Analytics BankFocus Research 17 June 2019 Exhibit 3: Impaired loans / Gross customer loans & advances, YE 2018 vs YE 2017 (%) Company Name Country 2018 2017 Change UniCredit Italy 8.1 11.1 -3.0 Bankia Spain 6.3 8.8 -2.5 Caixa Spain 4.8 6.2 -1.4 Sabadell Spain 4.4 5.4 -1.0 KBC Belgium 4.4 6.3 -1.9 BNP France 4.3 5.0 -0.7 BBVA Spain 4.2 5.0 -0.8 Intesa Sanpaolo Italy 4.2 12.9 -8.7 Santander Spain 3.7 4.2 -0.5 BPCE France 3.2 3.5 -0.3 Credit Agricole France 2.6 3.1 -0.5 ABN AMRO Netherlands 2.2 2.5 -0.3 Nordea Finland 1.5 1.9 -0.4 La Banque Postale France 1.5 1.4 0.1 Commerzbank Germany 1.4 2.5 -1.1 HSBC United Kingdom 1.3 1.6 -0.3 Lloyds United Kingdom 1.3 1.7 -0.4 Handelsbanken Sweden 0.4 0.4 0.0 However, despite these benign trends a broader look at the asset quality of the European banks still paints a challenging picture. If we include Stage 2 loans3 in the asset quality calculations, the majority of European banks’ extended asset quality ratios were at double digit levels as at end-2018. Under IFRS 9 Stage 2 loans are defined as performing but with a significant increase in credit risk since origination and may indicate higher propensity of borrowers to default. Exhibit 4: Stage 2 & Stage 3 loans / Gross customer loans & advances, YE 2018 (%) Company Name Country 2018 Company Name Country 2018 UniCredit Italy 16.8 Credit Agricole France 10.2 KBC Belgium 15.7 Santander Spain 9.5 BNP France 15.4 HSBC United Kingdom 7.5 BPCE France 13.6 ABN AMRO Netherlands 6.9 Bankia Spain 13.4 Nordea Finland 6.2 BBVA Spain 12.1 Commerzbank Germany 5.6 Caixa Spain 12.1 La Banque Postale France 4.0 Sabadell Spain 10.5 Handelsbanken Sweden 3.0 Lloyds United Kingdom 10.2 3 Impairment on Stage 2 loans (underperforming) is recognised on the basis of lifetime expected credit losses. This is a principal difference from IAS 39 provisioning approach of incurred but not reported events 4 Moody’s Analytics BankFocus Research 17 June 2019 Total provisioning coverage of impaired loans also improved In light of the lower impaired loan ratios, the total provisioning coverage has also improved as at end-2018. The average provisioning coverage ratio was 59% as at end-2018 compared to 52% end-2017, in line with the general improvement in the asset quality ratio.