“Covid decoupling” between loan-loss provisions and delinquency rates

Funcas, the “think tank” of the CECA (Spanish Confederation of Savings Banks) has released its "Economic Information July-August" report. The report analyses the decoupling between the stable delinquency rates and the high volume of provisions since the outbreak of Covid-19. The analysis indicates that “Spanish financial institutions would still have to provision a volume similar to the registered in 2020, just over €12 billion of credit impairments distributed in the income statements for 2021 and 2022.

Since the beginning of the pandemic and against all odds, we have witnessed a profound asynchrony between the evolution of delinquency rates and the cost of risk (measured as the volume of provisions over average total assets):

• While delinquency rates remained stable or even improved (in a context of a Spanish GDP fall around 11%), due both to an increase in gross credit (in the first half of 2020 as a result of ICO guarantee lines) and to the fall in non-performing loans and doubtful assets, thanks to accounting flexibility measures and explicit support for debtors (moratoriums, public guarantees and temporary employment regulation files).
• The cost of risk increased sharply in 2020, anticipating future increases in non-performing loans (NPLs) and doubtful assets. Provisions tripled the levels recorded during the two years prior to the pandemic. And although this provisioning effort has decreased substantially in the first quarter of 2021, it is still almost double the average level of the two years prior to the pandemic.

Is the relaxation of provisions at the beginning of the year justified? According to the report, doubtful assets and non-performing loans will keep on the rise until the beginning of 2023, while loan–losses provisions will remain strong until 2022, although below levels recorded in 2020:

• According to the analysis, the peak of doubtful credits, after growing about €40,000 million in 2021 and 2022, would be reached between the end of 2022 and early 2023. In 2024 NPLs would be slightly above pre-COVID levels.
• For this scenario and assuming an average coverage rate of 60%, the necessary provisions in three years (including 2020) will be around €24 billion. Thus, Spanish entities would still have to recognize over €12 billion of credit impairments in the income statements of 2021 and 2022.