May 22, 2020/Fitch Ratings
Asset quality for U.S. banks is expected to deteriorate significantly as a result of the coronavirus pandemic, but it could take some time for the true impact to show on bank financial statements, according to a dashboard report from Fitch Ratings. The ultimate increase in nonperforming loans and credit losses from the recession will be difficult to determine due to forbearance programs and measures taken by lawmakers and bank regulators to support credit availability.
Reporting standards for banks have been relaxed under the Coronavirus Aid, Relief and Economic Security Act (CARES Act), which means that impaired loans and troubled debt restructures (TDRs) could be understated in the near term. Fitch expects that recognition of impaired loans to be delayed for several quarters, potentially into 2021, depending on the duration of forbearance programs.
Asset quality for U.S. banks has been stellar in recent years with low levels of nonperforming loans and credit losses, but asset quality will weaken significantly. Nonperforming loans made up less than 1% of total banking sector loans at the end of 2019 compared with over 5% at their peak following the global financial crisis of 2008-2009.
“The sheer scale of coronavirus relief measures poses reputational risks for banks if mishandled or implementation is poor,” said Michael Shepherd, Director at Fitch Ratings. “Disaster relief and forbearance programs are not a new phenomenon, but the breadth and scale/volume of coronavirus-related loan modifications create operational challenges for banks and could result in customers being negatively affected, tarnishing bank reputations.”
Bank earnings were hampered in 1Q20 due to significantly higher provisions expenses that were about five times provisions expenses incurred in 4Q19. These provisions reflect increases in credit loss expectations as a result of the coronavirus pandemic under the new current expected credit loss (CECL) accounting standard that most large banks adopted in 1Q20. Under CECL, banks are required to estimate life of loan losses using their own assumptions such as economic forecasts and credit exposures. Provisions expenses and allowance coverage can vary greatly, and differing underlying assumptions result in a lack of comparability from bank to bank.
Forbearance programs could artificially inflate bank earnings in the coming quarters because banks can generally continue to accrue interest on loans subject to forbearance if the borrower was current on their obligations when forbearance was granted. If the borrower is not able to repay when the forbearance period ends, banks could incur a loss that was not reported in earlier quarters.
“Regulators have eased requirements to shield banks from the full impact of CECL in order to boost lending, but this could inflate reported regulatory capital ratios,” added Shepherd.