Second-quarter credit loss provisions at the largest 25 European banks offered a mixed picture, with levels dropping at 10 companies and increasing at 15, compared to the previous quarter, S&P Global Market Intelligence data shows.

As they did in the first three months of the year, U.K.-based HSBC Holdings PLC and Spain's Banco Santander, SA made the largest absolute amount of provisions in the second quarter, although Santander, despite booking the largest second-quarter net loss among the banks in the sample, posted lower provisions versus the first three months.

Posting the fourth-largest loss among banks in the sample, British bank Lloyds Banking Group PLC also posted the third-largest amount of provisions in the second quarter, followed by U.K.-based NatWest Group PLC, which was also among the biggest loss-makers in the period.

Diverging models

European banks adjusted their economic assumptions over the second quarter and became closer aligned regarding their expectations about the future macro environment, but there is still divergence in provisioning levels across the sector. This is due to differences in the banks' expected loss models and their varied approaches toward front-loading of provisions, according to analysts.

The probability-of-default and loss-given-default estimates used in expected loss models vary across credit institutions even though the economic assumptions in the sector are now more harmonized, Berenberg analysts said in an Aug. 11 note. Some banks also decided to front-load full-year cost of risk in the second quarter, they said.

Front-loading

Both Belgium-based KBC Group NV and Finland-based Nordea Bank Abp, which booked the highest quarter-over-quarter rise in provisions, front-loaded their full-year cost of risk. Despite not seeing any "material deviations" in the probability of default caused by COVID-19 so far, KBC decided to book all expected credit losses relating to the pandemic for the remainder of the year in the second quarter, CEO Johan Thijs said at the bank's earnings presentation on Aug. 6.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

KBC hiked its COVID-19-related provisions to €746 million in the second quarter, from €43 million in the first. The lion's share, namely €596 million, was booked as a so-called management overlay, additional reserves management can set aside under IFRS 9 accounting standards in anticipation of the impact of major events. Another €150 million stemmed from "impairments captured by the ECL models through the updated IFRS 9 macroeconomic variables," the bank said.

Nordea's CEO, Frank Vang-Jensen, told analysts at the bank's earnings presentation July 17 that €388 million out of the bank's total second-quarter loan loss provisions of €698 million were booked as management overlay, while underlying net loan losses were €310 million.

"We have now a total buffer of €650 million to cover future loan losses and IFRS 9 model improvements," Vang-Jensen said. "All in all, these provisions are expected to mostly cover the full year loan losses."

Spanish CaixaBank SA has also taken a front-loading approach and almost doubled its COVID-19-related provisions to €755 million in the second quarter, from €400 million in the first. Thanks to the front-loading, the bank expects cost of risk to decline in 2021 from 2020 levels, CEO Gonzalo Gortázar said at an earnings presentation on July 31.

H2 and beyond

Banks' provisioning is likely to be lower in the second half of 2020, given that banks' models have now been adjusted to incorporate the worsening macroeconomic environment and the actual defaults are still to fully emerge, which is most likely to happen once the loan moratoria come to an end later in the year or in 2021, Elisabeth Rudman, head of the European Financial Institutions Group at DBRS Morningstar told S&P Global Market Intelligence.

The wide variety of provisioning approaches across banks and countries in Europe, particularly in terms of the level of Stage 2 provisions, may also lead to higher provisions in 2021, according to Rudman. Under IFRS 9, Stage 2 are provisions for loans with a significant increase in credit risk. Following the EU regulators' guidance in early 2020, many banks have refrained from moving loans in forbearance into Stage 2 from Stage 1, which is the classification for performing loans under IFRS 9.

"We would expect that once the level of defaults is more clear, some banks will still have significant provisioning needs in 2021," Rudman said.