Despite European governments' measures to contain the sanitary effect of the COVID-19 pandemic on their population, they face an unprecedented challenge to their economies. The economic outlook has steadily worsened in recent weeks, mainly because of stricter public health measures across Europe and in many countries around the world to combat the coronavirus. We now expect GDP in the eurozone and U.K. to shrink by 7.3% and 6.5% this year before rebounding by 5.6% and 6% in 2021. Even under this gloomier outlook, risks remain skewed to the downside at least until a vaccine can be developed. The ongoing global recession is different from the global financial crisis, however, which was the consequence of excessive leverage. In contrast, the current global recession has been intentionally induced by governments in their efforts to contain a global pandemic. Most European financial and nonfinancial institutions enter the current maelstrom with considerably lower levels of debt.

We continue to expect the wide-ranging fiscal and related monetary measures to substantially mitigate this extraordinarily sharp, cyclical shock to European economies, and so also to support national banking systems. However, even under our base case of an economic recovery starting in third-quarter 2020, we expect bank earnings, asset quality, and in some cases, capitalization, to weaken meaningfully through end-2020 and into 2021. Furthermore, the COVID-19 crisis is an unwelcome complication for banks that were already wrestling with two paramount questions: how to harmonize balance sheet strength with solid investor returns, and how to refine business and operating models in the face of the looming risks and opportunities of the digital era.

Our negative rating actions on European banks in the past week, predominantly outlook revisions, stem primarily from COVID-19 implications, but in some cases also reflect existing profitability pressures that potentially become more intractable as economies stumble (see tables 1 and 2). These actions follow those on individual banks in Europe and beyond in previous weeks where we saw the existing assumptions underlying our ratings as particularly challenged (see “How COVID-19 Is Affecting Bank Ratings,” published April 22, 2020).

While our ratings on many European banks predominantly now carry negative outlooks, we continue to see differentiated implications across banks in these systems. Banks are all a function of the economies that they serve, but they bring their own blend of strengths and weaknesses. We could take further negative rating actions if we expect the cyclical economic recovery to be substantially weaker or delayed, as this would imply a far more negative effect on bank credit strength. Actions could also follow idiosyncratic negative developments at individual banks. While far from being the only factor, bank asset quality is the key unknown and will be central to our view of the resilience of European banks.

After the past week of rating actions, we generally see pressure weighing on these banks' stand-alone credit profiles (SACPs). This indicates the heightened risk of a one-notch downgrade for subordinated and hybrid instruments, including senior nonpreferred ones. This also applies to several continental European banks with stable outlooks on their main operating entity. The stable outlook reflects a high degree of protection offered to senior bank bondholders via the issuance of large volumes of bail-inable debt, which could absorb losses in resolution. This view is consistent with the negative outlook we have on nonoperating holding companies of banking groups in the U.K. and elsewhere.

S&P Global Ratings LIVE: EMEA Financial Institutions Market Update

Please join our leading S&P Global Ratings' analysts from the Financial Institutions team for a live webinar on Thursday, 30th April at 2:30pm London, 3:30pm Central Europe, and 9:30am New York time, where they will provide their views on the latest industry credit outlook for European banks. Key discussion topics will include:

• Key credit trends for European banks
• Overview of recent rating actions
• Update on Q1 results

To register, please paste the following link into your browser: https://console.on24.com/eventRegistration/EventLobbyServlet?target=reg20.jsp&referrer=&eventid=2315532&sessionid=1&key=DF6E07F40BD690F3EC82ECFED69B7AE5&regTag=&sourcepage=register

Table 1

Table 2

Frequently Asked Questions

What is S&P Global Ratings' economic base case and why has it changed in recent weeks? (Updated)

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications.

Countries' actions to slow the spread of the virus are the key driver of our economists' forecasts. In recent weeks, most European countries have extended these measures and are foreseeing a rather gradual loosening of social distancing. Those are the two key reasons S&P Global Ratings now forecasts a deeper recession than we did just about three weeks ago (see “Economic Research: Europe Braces For A Deeper Recession In 2020,” published April 20, 2020). We now assume eight weeks of lockdowns on average (up from six previously) and a much more gradual reopening. Additionally, we assume some social-distancing measures will have to stay in place until a viable treatment or vaccine are found, which could be mid-2021.

Services-led, especially tourism-dependent, economies are set to suffer more, as well as those where lockdowns are more restrictive. By contrast, bigger fiscal support through credit and job guarantees should lead to a swifter recovery. For example, to date Germany has unveiled the biggest fiscal bazooka: Contingent liabilities and the direct fiscal costs amount to more than 30% of GDP, compared with just around 8% for Spain (see "Credit Conditions Europe: The Lowdown On Lockdowns," April 28, 2020).

Another set of factors informing our more pessimistic outlook is linked to a worsening external environment. We now expect global GDP to shrink by 2.4% this year. Notably for Europe, we now forecast a deeper recession in the U.S., the main destination for the region's exports. Also, lower world oil prices, if they last, might dampen external demand in OPEC and Russia, which together account for more than 7% of European goods exports--half as much as the U.S. This will undermine some of the benefits Europe is deriving from the lower inflation associated with lower oil prices and means that the eurozone recovery will take longer than we had initially expected.

Our economists see mostly downsides to this forecast arising from factors such as:

• The pandemic evolving differently than we currently assume. If the virus resurges, this could involve possibly longer lockdowns or interruptions in loosening the social-distancing measures. The lockdowns don't affect the economy in a linear way: the longer they last, the more they play into investment decisions, tear the economic fabric, and lower GDP prospects.
• Worsening financing conditions. Interest rates are now significantly lower than during the eurozone crisis--an average 370 basis points lower for the four largest European economies.
• The possibility of higher financing costs shaking the riskier, currently more fragile areas of the financial markets, such as the equity markets and the speculative-grade bond market. This might cause more companies to default and jeopardize their recovery.
• Further worsening of Europe's external environment if the economic impact of the pandemic is more pronounced in the U.S. or Asia, Europe's main trading partners.

Why are you only talking about bank outlook revisions at this time?

Like their global peers, European banks inevitably face negative rating consequences as a result of the significant effects of the coronavirus pandemic, oil shock, and market volatility. Yet, we anticipate this will mostly be limited to negative outlook revisions over the next few quarters, with a comparatively smaller proportion of downgrades. We expect bank ratings to stay largely resilient for four key reasons:

• The generally strong capital and liquidity position of banks globally at the onset of the pandemic, supported by a material strengthening in bank regulations over the past 10 years;

• The substantial support and flexibility that European banking systems will receive from public authorities to entice them to continue lending to households and corporates, whether in the form of liquidity or credit guarantees, and relief on minimum regulatory capital and liquidity requirements;

• The unprecedented direct support that governments are providing to their corporate and household sectors; and

• The likelihood, in our base-case scenario, of a substantial rebound in GDP in 2021 after a sharp contraction this year, even if this contraction and ensuing recovery varies considerably between countries and does not totally make up lost ground.

You reviewed many European banking systems, but not all. Should we expect more rating actions? (Updated)

Our rating actions since the onset of the crisis have focused on those issuers whose ratings we see as potentially more exposed to weakening operating conditions. In the past week, we have taken substantial negative rating actions on banks in Belgium, France, Germany, Iceland, Ireland, Italy, The Netherlands, Spain, and the U.K.--as well as on individual banks in other Western and Central European banking systems.

We also revised our assessment of banking industry and country risk for Czech Republic, Croatia, Hungary, Poland, and Slovenia. We now see economic risk trends as:

• Stable for Hungary and Slovenia, rather than positive;
• Negative for Poland, rather than stable;
• Remaining stable for Czech Republic and Croatia.

For industry risk, we see the trend remaining negative for Poland and stable for the other four CEE (Central and Eastern European) countries. Our ratings on the banks in these countries were unaffected by these changes as we consider that there is generally sufficient buffer in the current ratings to allow for an increase in economic risk. However, the deteriorating environment could yet affect individual bank ratings (see “Deepening COVID-19 Risks Cause Economic Risk Trends To Shift In Several CEE Countries,” April 29, 2020).

We will continue to take rating actions (including outlook revisions) on European banks in response to evolving macroeconomic and bank-specific developments, especially if we see a further increase in the downside risk to our base-case scenario.

In determining which bank ratings could be affected the most, we take into account the headroom within individual bank ratings for some deterioration in their credit metrics as well as their relative exposure to the most vulnerable sectors and customers. We also consider the relative effectiveness of their public authorities in curbing the credit impact on customers and supporting a rapid rebound once the situation abates.

Our analysis also notably takes into account that many Western European banks outside Scandinavia entered this crisis with structurally weak profitability. This provides a diminished buffer to absorb a spike in credit losses before capital is eroded.

What assumptions have you made on bank asset quality and forbearance?

The COVID-19 pandemic will result in most European banks applying forbearance measures across their loan books. It also raises questions about the future shape of loan provisioning under IFRS 9--a standard that has not yet seen a full economic downturn. We don't currently see forbearance measures as an indication of a sharp rise in future credit losses, but losses will inevitably rise through 2020 and banks' transparency in reporting will be important to investor confidence.

We do not expect a knee-jerk reaction of additional, mechanical provisioning to appear in European bank results for the first quarter or beyond, as long as the assumption of a temporary shock and quite rapid recovery plays out in practice (see “European Banks' First-Quarter Results: Many COVID-19 Questions, Few Conclusive Answers,” published April 1, 2020). In particular, as long as unemployment remains low, we expect no spike in retail mortgage provisioning. However, this does not mean that banks will be immune to seeing and reporting a rise in credit losses in 2020, including for the first quarter. Far from it, in fact, as we see several factors that will drive up provisioning:

• Writebacks/releases, which have helped keep provisioning low in recent years, were already coming to an end--one reason why our pre-COVID base case was for a moderate, but discernible rise in European bank impairments in 2020;
• Corporate borrowers in some industries—leisure and tourism, oil and gas, and shipping to name a few--have likely not undergone a temporary weakening, something that banks will have to recognize sooner rather than later; and
• Some borrowers will never recover, which could be for two reasons. First, despite ultra-cheap debt, they were already struggling amid Europe's slow-growing economies and marked structural trends in consumption, or second, the mitigation provided by fiscal stimulus--much of which leads to the roll-up of debt not the avoidance of it--is too little or too late to be of practical help to those borrowers.

Overall, we expect corporate and SME lending to be more challenged than retail mortgage lending, and some banks' and banking systems' loan books are far more weighted to corporate lending (including SME) than others.

What's more, this effect becomes more profound under the adverse case of ineffective mitigation of economic stress and/or delayed or sclerotic economic recovery.

What key factors will inform your next move?

Our rating analysis will continue to blend broad, macroeconomic and environmental factors with the idiosyncrasies of individual banks' profiles. There are two factors central to the broad picture:

The length of the lockdown.  The economic impact is mainly due to a drop in household consumption, which has been severely restricted by government measures, in particular lockdowns, to contain the spread of the virus. However, the effects on economic activity are not proportionate: The longer restrictive measures are in place and the longer the public health outlook remains unclear, the more disproportionately the economy will suffer. For example, higher uncertainty and longer constraints to economic activity mean more businesses will likely fail, leading to higher rises in unemployment, more losses of wealth and capital, and therefore a slower recovery.

The effectiveness of fiscal and monetary measures.   We see far-reaching fiscal and monetary measures in essentially all European countries. Bigger fiscal support should lead to a swifter recovery, but even under our economic base case, these policy responses are likely to be less than totally successful in avoiding permanent economic damage later. A significant component of the fiscal support package comprises additional indebtedness--for the sovereign, some households, and many businesses. The longer the delay in the recovery of economic activity, the less sustainable this extra debt will be. Furthermore, some aspects of support, such as the partial unemployment schemes unveiled across Europe, are likely to protect workers differently depending on the sector. Manufacturing and higher-skilled workers are set to be better protected by these schemes than lower-skilled, temporary, or seasonal workers from the tourism industry, who will more likely become unemployed. As a result, the unemployment rate may rise more sharply in some countries than others.

While we expect a common trend here across European banking systems, economic structure and fiscal support (in its size, blend, and deployment) differ from country to country; therefore, so could the implications for the banks.

Additional, bank-specific, factors include:

• The current rating level, including to what extent there is room within it for a deterioration in credit metrics.
• The relative exposure of the bank to hard hit industries (such as transportation, tourism, oil and gas, gaming, lodging, restaurants, and transport sectors) or types of lending (such as SMEs, leveraged loans, and unsecured consumer loans). Banks' relative exposure to possible fund outflows (as is the case in certain emerging markets) or concentration risk to single name exposures or particular industries may also exacerbate issuers' vulnerabilities.
• The existence of other positive and negative pressures. For example, some banks already faced significant challenges in restructuring their business and operating models to boost weak profitability. By contrast, while we would be cautious in our assumptions on banks' ability and willingness to issue subordinated debt in volume in the coming months, given disrupted markets and higher spreads, some bank issuer credit ratings (ICRs) (and issue ratings on senior preferred debt) could be supported by additional loss-absorbing capacity (ALAC).

Taking all this together, future negative rating actions, if they arise, could well be country-specific or idiosyncratic, rather than across the European landscape.

Do you expect to see liquidity stress in the European bank sector?

Corporates and SME drawdowns on committed facilities are one of several causes of significant liquidity outflows at many European banks, although some of these funds have since been redeposited. Overall, we expect that many banks' regulatory liquidity coverage ratios are likely to have declined in the first quarter and could decline further through the rest of the year. While we continue to monitor developments here, we currently consider it fairly unlikely that bank funding and liquidity would be a source of rating pressure, certainly in a general sense.

This reflects the good starting position of many banks, and central banks' very supportive stance (expanded long-term refinancing operations, easier collateral requirements, and cheap pricing), which substantially mitigates liquidity risks. That said, funding costs, particularly the pricing for bank hybrid issuances including senior nonpreferred, are likely to remain elevated and the market might reopen only very slowly for weaker names.

We therefore believe that liquidity stress would more likely relate to banks whose ratings rely on projected issuances of senior nonpreferred or capital instruments, particularly where they have less solid market access or limited capacity to absorb a higher cost of funding.

Are you expecting banks to see big hits to capitalization? At what point would you be more concerned about AT1 coupon nonpayment risk?

Although we expect that European banks will generally continue to pay additional Tier 1 (AT1) coupons, AT1 hybrids can absorb losses on a going-concern basis, not just in resolution. At this point, we largely expect that banks won't need to consider nonpayment of AT1 coupons. The regulatory response to the COVID-19 outbreak--cutting buffer requirements and squeezing shareholder distributions--aims to encourage banks to extend credit to the real economy without fear of breaching regulatory requirements. We note also regulators' statements such as that from the European Central Bank's (ECB's) Prudential Supervisory Board that it has no plans to suspend payments on bank hybrids.

However, while we don't see coupon nonpayment as a tool that banks will generally need to use, it could become more relevant to banks that face increased and sustained pressure on their creditworthiness. We reflect these payment risks by applying a gap of at least four notches between the stand-alone credit profile (SACP) of a bank and the ratings on its AT1 hybrids.

For more on our views on AT1s and the AT1 market more broadly, see "Europe's AT1 Market Faces The COVID-19 Test: Bend, Not Break," published April 22, 2020.

Are there negative long-term implications of regulatory easing?

We will monitor the long-term effect of the current relaxation of various bank regulations, for instance in terms of capital buffers and forbearance. The short-term impact over the next few months is likely to be positive for banks. It should enable them to maneuver through the worst part of the crisis, and in line with the original intentions of these regulations. Chiefly, it gives banks more flexibility to manage the immediate--supposedly short-lived, but acute--crisis.

But it is still too early to predict whether some of these changes could become more durable. If so, a long-term weakening in banks' capital and liquidity targets, or less transparency in recognizing bad debt and delays in adequately provisioning for it, could lead to durably weaker balance sheets and erode investor confidence. A weakened prospective capitalization of banks could affect a number of ratings over time, both in developed and emerging markets.

Why haven't advanced European sovereign ratings moved? (New)

Since the WHO reported the initial indications of a new Coronavirus in Wuhan, China on Dec. 31, 2019, S&P Global Ratings has taken a series of sovereign rating actions. The vast majority of these have been in emerging markets with limited monetary flexibility, high stocks of foreign currency debt, and dependency on commodity exports, particularly oil. We have taken a far more measured approach for the ratings of advanced economies, which can print reserve currencies. Indeed, since March 1, we have not changed the ratings on any OECD (Organisation for Economic Co-operation and Development) member except Mexico, though we have revised the outlooks on several European sovereigns from positive to stable, including those of large net exporters of tourism such as Greece, Malta, and Portugal. While there can be no doubt that, as ECB President Lagarde has said, the COVID-19 pandemic is "one of the greatest macroeconomic cataclysms of modern times," we are determined to take a deliberate approach toward assessing its long-term impact, if any, on advanced economies' ability to create wealth.

Without a doubt, the combination of a severe and synchronized global recession, a standstill of domestic demand, and extraordinary fiscal measures will increase gross general government debt for 2020 by well over 15% of GDP in most OECD member states. However unlike companies, sovereigns can create the currency in which they fund themselves. In the Americas, Asia, and in Europe, G20 central banks are backstopping governments' emergency fiscal response to the global pandemic. The European Central Bank (ECB) has committed to purchasing an additional 9.4% of GDP of public and private securities this year on a flexible basis (including Greek government bonds for the first time since 2015 under the newly created PEPP Asset Purchase Program). Eurozone government bonds could also quickly be made eligible for unlimited ECB purchases under the Outright Monetary Transactions (OMT) Program originally announced by Mario Draghi in September 2012, but so far never activated. In the U.K., the Bank of England is set to expand its balance sheet by a projected 10%/GDP this year, and is directly financing the Exchequer via the Ways and Means overdraft account. As a consequence, across wealthy sovereigns, while debt to GDP soars, Central Banks are ensuring that the cost of refinancing debt is negative in real terms.

What will determine the trajectory of sovereign ratings moving into 2021 is our consideration of the fallout from COVID-19 on long-term growth potential. There are questions regarding how quickly key sectors such as tourism, transportation, and retail services can recover from a process of de-globalization triggered by the global pandemic. However, we do not anticipate the level of ratings downgrades that eurozone sovereigns experienced between 2009 and 2012, when a eurozone balance of payments crisis drove a multi-year debt crisis. There are several reasons for this:

• Sovereign ratings in Western Europe today are well below where they were in 2008.
• The external imbalances that existed previous to the 2009-2012 global financial crisis are long gone. As an example, the Italian economy has shifted from being a net borrower from the rest of the world on a flow basis to becoming a significant net lender, an adjustment of about 6%/GDP since 2009. The same is the case for Ireland, Portugal, and Spain.
• Finally the Economic and Monetary Union, and in particular the ECB, have acquired considerable crisis-fighting tools since 2012, and has already shown a willingness to use them.

None of this means that the world and its economies will be the same after this is all over, or that the long-term economic consequences from COVID-19 won't weigh on creditworthiness over the long term. But, in our opinion, it is too early to judge whether this has weakened wealthy European governments' ability to service their commercial debt.

What connectivity--direct or indirect--is there between bank and sovereign ratings? (New)

European banks' creditworthiness remains intertwined with that of Sovereigns to a degree, because the same underlying economic developments can affect both--something we would usually reflect in our BICRA economic risk assessment for banks. However, beyond this, the extent of this correlation/connectivity varies significantly across the region. It tends to be a more relevant factor in countries like Italy or Portugal, where our view of some of the stronger banks in the system is constrained by our view of sovereign creditworthiness. Furthermore, while rarely a rating driver of itself, some banks have proportionately a far greater exposure to their domestic sovereign than others.

What does forbearance mean for covered bond ratings? How far would bank ICRs have to fall before the ratings on those issuers' covered bonds were lowered?

Due to the dual-recourse nature of covered bonds, their ratings are typically linked to the relevant rating on the covered bond issuer, i.e., the issuer credit rating (ICR). This dual-recourse nature means that it's unlikely that a deterioration in short-term liquidity caused solely by mortgage forbearance initiatives would lead to the downgrade of covered bond programs. However, changes to issuer credit ratings can directly affect the ratings on covered bond transactions that do not have so-called "unused notches of uplift" available under our criteria. Currently, most issuers in most countries have unused notches available, which may be utilized should the ICR deteriorate. Programs without unused notches are spread across jurisdictions, and are mainly a result of relatively low ICRs or limits to the jurisdictional or collateral support elements of our ratings analysis (For more details and an overview of unused notches, see “Global Covered Bonds: Assessing The Credit Effects Of COVID-19,” March 26, 2020.)

Related Research (Updated)

• Outlooks Revised To Negative On Several Spanish Banks On Deepening COVID-19 Downside Risks, April 29, 2020
• Outlooks On Most Italian Banks Now Negative On Deepening COVID-19 Downside Risks, April 29, 2020
• Outlook Revisions On Several Austrian Banks On Deepening COVID-19 Downside Risks, April 29, 2020
• Deepening COVID-19 Risks Cause Economic Risk Trends To Shift In Several CEE Countries, April 29, 2020
• Outlooks Revised On Three Irish Banks On Deepening COVID-19 Downside Risks, April 28, 2020
• Credit Conditions Europe: The Lowdown On Lockdowns, April 27, 2020
• Three Icelandic Banks Downgraded On Weaker Business Prospects And Effect Of COVID-19; Outlooks Stable, April 24, 2020
• Outlooks Revised On Six U.K. Banks On Deepening COVID-19 Downside Risks, April 23, 2020
• Negative Rating Actions Taken On Various French Banks On Deepening COVID-19 Downside Risks, April 23, 2020
• Negative Rating Actions Taken On Multiple Benelux Banks On Deepening COVID-19 Downside Risks, April 23, 2020
• Negative Rating Actions Taken On Multiple German Banks On Deepening COVID-19 Downside Risks, April 23, 2020
• Bank of Valletta Outlook Revised To Negative On Sharp Economic Contraction; Ratings Affirmed, April 23, 2020
• How COVID-19 Is Affecting Bank Ratings, April 22, 2020
• Europe’s AT1 Market Faces The COVID-19 Test: Bend, Not Break, April 22, 2020
• EU Response To COVID-19 Can Chart A Path To Sustainable Growth, April 22, 2020
• Economic Research: Europe Braces For A Deeper Recession In 2020, April 20, 2020
• COVID-19 Deals A Larger, Longer Hit To Global GDP, April 16, 2020
• European Banks' First-Quarter Results: Many COVID-19 Questions, Few Conclusive Answers, April 1, 2020
• COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
• Global Covered Bonds: Assessing The Credit Effects Of COVID-19, March 26, 2020
• COVID-19 Countermeasures May Contain Damage To Europe's Financial Institutions For Now, March 13, 2020