Following torrential rain in parts of Germany, Austria, the Czech Republic, and Poland, some areas have seen rivers overflow and widespread flooding. That said, river flooding is a known risk in the region and S&P Global Ratings expects the fiscal architecture established to handle previous catastrophes to cushion the financial impact for the local and regional governments (LRGs) affected. Furthermore, we anticipate that the floods will have only a limited impact on profitability at local banks. We do not expect our ratings on regional LRGs or banks to be affected.

Local And Regional Governments

Austria

The Federal State of Lower Austria (AA/Stable/A-1+) has been severely hit by torrential rain, overflowing rivers, and even some landslides. That said, damage from the current flooding has mostly been confined to this single state and has largely spared its Austrian peers.

Austria has well-established procedures to handle the financial consequences of such physical damage, although these vary from state to state. Under local laws, Lower Austria is expected to compensate private individuals for 20% of the financial losses they incur as a result of such catastrophes--taking into account any compensation individuals receive from insurance companies. Where infrastructure has been damaged, the state is also expected to compensate municipalities and pay the full repair and rebuild cost. The central government then reimburses up to 60% of Lower Austria's flood-related budgetary outlays from its national catastrophe fund.

The floods in 2002 provide a means of estimating the potential impact on Lower Austria's budget. Assuming that the volume of physical damages is similar and adjusting both the compensation paid to victims and the level of federal reimbursement for inflation, we estimate that the net effect on Lower Austria's budget could be close to €150 million, a burden equivalent to about 1.7% of its expected operating revenue for 2024. In our view, Lower Austria has sufficient financial flexibility to absorb a one-off outflow of this magnitude at the current rating level.

Given the Austrian federal government's recent announcement of an increase in the size of its national catastrophe fund to €1 billion, from €300 million, it might appear that we underestimate the potential net burden. Full utilization of the upsized national fund could imply greater spending on flood compensation by Lower Austria. However, Austria's general elections are due to take place on Sept. 29, and we believe that last-minute campaigning may have prompted a headline increase that exceeds the actual need.

Germany

Currently, the physical damage caused by flooding in Germany seems to be relatively limited. Although high watermarks have been recorded in Saxony and Bavaria, no major damage has been observed. Therefore, we do not expect the country to invoke any national burden-sharing mechanism to cover the cost. In 2013 and 2021, when Germany experienced severe flood events, the fiscal consequences were shared by all 16 regional states as well as the federal government. The states are still repaying their share of the costs.

The mechanism was used because Germany compensated private individuals affected by the 2013 and 2021 flood for about 80% of the losses they had incurred, well above the percentage offered in Austria. As a result, Germany's flood-related financing needs were significantly larger.

Following both the recent flood events, the German federal government fully pre-financed the establishment of a special compensation fund. It allocated €8 billion to the fund in 2013, of which the states committed to refunding about half over 20 years. In 2021, it allocated €30 billion, of which the states committed to repay about a quarter over 30 years. The 16 federal states distributed their share of the cost by population.

Practically all funds went to just a few flood-affected states:

• Saxony-Anhalt, Saxony, and Bavaria in 2013; and
• North Rhine-Westphalia and Rhineland-Palatinate in 2021.

Notably, many of the states that contributed had no flood damages on their territory at all. The annual burden of each flood event was, however, relatively similar for each of the German states, that is, less than 0.1% of annual operating revenue over a number of years.

Central and Eastern Europe

We rate three local governments in Poland and the Czech Republic: Krakow and Lodz in Poland, and Brno in the Czech Republic. These have so far reported only negligible physical damage and we expect the primary impact of the floods to be administrative. So far, the financial impact is immaterial and, in our view, unlikely to affect our ratings on these LRGs.

Most of Brno's physical damage was contained by a dam and other mitigating measures. As a result, it has weathered the floods better than other cities in the Moravian region.

Nevertheless, we see potential for the floods to have some second-round fiscal effects in the medium to longer term. For example, other parts of Poland and the Czech Republic could require high flood-related support, which could then weigh on local public finances by prompting central governments to redirect or reduce transfers.

Impact On Banks

The full effect of the recent flooding on the region's banking systems cannot yet be assessed. Our stable outlooks on rated banks indicate that we do not expect the impact on bank profits to be material. Based on recent examples, such as the flooding in Slovenia and Southern Austria during 2023, such events are likely to have a limited effect on bank earnings. Nevertheless, risk managers are likely to see the floods as further evidence of the importance of managing physical risk exposure linked to weather-related events.

Although financial losses are hard to predict, we consider that banks' solid earnings and capital buffers provide them with comfortable coverage to mitigate the risk. Mid-year results for 2024 at most European banks--including those for banks in the affected countries--suggest that credit conditions remain relatively benign. Not only has the delay in cutting policy rates supported banks' net interest income but also asset quality has deteriorated by less than we expected. We now predict that earnings at most European banks will remain robust into 2025, even if earnings growth slows significantly, compared with previous years.

Floods could have a significant effect on certain segments of the economy and in some regions, we expect most of the region's banks to be able to contain the deterioration in their asset quality metrics. Banks' efforts to work out nonperforming loans in recent years, while improving their lending standards, suggests that the starting point for the expected deterioration in asset quality is relatively low, for most. Although the flood could increase credit costs, this would merely add to the normalizing trend--credit costs have been historically low until recently.

Insurance coverage could moderate the floods' net impact on banks and we expect risks to be further mitigated by state support to troubled companies and private households. For example, after floods affected Slovenia in August 2023, the European Commission supported the country by providing emergency funds. In our view, the loans most vulnerable to present a risk for banks will be those to small and midsize enterprises and consumers.

In addition, real estate assets and other collateral could be devalued after suffering flood damage, which could increase credit losses for banks. Rated banks in the region generally show few signs of concentrations in segments at higher risk of flood losses, such as agricultural companies. The impact at those banks that have higher exposure to troubled customers will be greater.

Related Research

• German State of Saxony 'AAA/A-1+' Ratings Affirmed; Outlook Negative, Aug. 30, 2024
• City of Brno 'AA-/A-1+' Ratings Affirmed; Outlook Stable, April 19, 2024
• Poland's City of Lodz 'BBB+' Ratings Affirmed; Outlook Stable, March 15, 2024
• Polish City of Krakow 'A-' Rating Affirmed; Outlook Stable, March 8, 2024
• German State of Bavaria 'AAA/A-1+' Ratings Affirmed; Outlook Stable, March 1, 2024
• Lower Austria, Feb. 12, 2024