Putting Off Virus Writeoffs to Widen EU Banks’ Gap With U.S.

(Bloomberg) -- When European banks report results in the weeks ahead, they won’t match their U.S. counterparts in setting aside the massive provisions needed to cover expected losses from the pandemic. They can’t afford it.

Ten of the region’s largest lenders would have to set aside $152 billion this year if they were to parallel the rate of the top U.S. banks. That would drive them all into the red. The six biggest U.S. lenders would still be in the black after provisions of $98 billion -- assuming they kept up the first-quarter pace -- or about 2.4% of their loan books for potential losses.

European lenders have received the blessing of their regulators to be flexible applying rules to avoid a spike in provisions, according to senior bankers and regulators. They are set to report comparatively small increases in loan-loss reserves in the first quarter and plan a similar approach the rest of the year.

Deutsche Bank AG said on Sunday it took 500 million euros ($543 million) of provisions in the first quarter. That’s about one-fifth of what it would have to set aside -- based on its 454 billion-euro loan book at the end of 2019 -- if it were to follow in the footsteps of its U.S. peers, according to Bloomberg calculations. The German bank, which reported a surprise profit for the quarter, said loan losses would probably increase in the rest of the year.

The trouble with the strategy is that, while sustaining profits, it will also undermine any potential recovery, according to JPMorgan Chase & Co. analyst Kian Abouhossein. The divergence repeats the cycle from the 2008 crisis, which has handicapped the European finance industry ever since.

“This approach of prolonging and delaying the pain would put European banks behind the curve once again in terms of cleaning up asset quality and hence concerns around true book value,” Abouhossein wrote in a note last week.

Delaying the recognition of losses led to what became known as zombie banks in Japan in the early 2000s; they remained saddled with bad debts following the end of the 1990s boom. Top European banks’ price-to-book ratios have already decoupled from U.S. peers in recent years, tracking more closely with Japan’s. While U.S. valuations rebounded, European and Japanese ones have slid lower.

The ratio shows investors’ confidence in whether assets are marked to their true value. If banks don’t write down losses accurately, investors will do it for them. European and Japanese banks’ ratios now average about 0.4 -- putting their market equity at less than half the stated value -- while for U.S. banks it has only just dipped below one.

Credit Suisse Group AG, the first universal bank based in Europe to report earnings, set aside 568 million swiss francs ($583 million) for loan losses in the first quarter, roughly a third of what U.S. peers did in comparison to the size of their loan books. That allowed the Swiss firm to announce a $1.3 billion profit for the quarter.

Some European countries haven’t even finished cleaning up after the last crisis. Non-performing loans still make up more than a third of total lending in Greece, 18% in Cyprus, and about 10% in Italy and Portugal. Another surge of bad loans will be tough to shoulder for those nations’ lenders. Some of those governments might have to bail out their banks once again, after being given the green light by the European Union last month.

“This comes on top of the decade-long divergence in banks’ fortunes on both sides of the Atlantic,” said Jan Schildbach, head of research for banking and financial markets at Deutsche Bank AG in Frankfurt. “U.S. banks had become much more profitable than their peers in the Old World. The current crisis may therefore pose a significantly greater threat to European than to U.S. banks.”

©2020 Bloomberg L.P.