German banks can fend off Russian gas cut thanks to loan diversity

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German Chancellor Olaf Scholz inspects a gas turbine for the Nord Stream 1 gas pipeline in Russia.
Credit: Andreas Rentz/Getty Images News via Getty Images Europe

Germany’s biggest banks should avoid a direct hit from a potential Russian gas shutdown thanks to their well-diversified loan portfolios, which will protect them from a severe deterioration in asset quality, bank executives and market watchers said.

Strong overall capitalization, low levels of bad debt and government support for companies in vulnerable sectors will also help, analysts say.

“We don’t see outsized exposure to a particularly vulnerable sector,” Sonja Förster, vice president of DBRS Morningstar’s Global Financial Institutions Group, said in an interview. Banks have carefully managed loan portfolio risk and diversified well, and much of the German corporate sector entered the COVID-19 pandemic with strong fundamentals, meaning widespread defaults in a single sector are unlikely, Forster said.

Germany is particularly sensitive to cuts in Russian gas imports, which accounted for 55% of the country’s total gas consumption in 2021, according to figures from energy industry association BDEW. Fears that Russia could halt all gas deliveries to Europe amid tensions over the war in Ukraine have intensified since June, fueled by a shutdown for maintenance of the Nord Stream 1 gas pipeline in July. Russia’s largest gas pipeline to Europe is currently operating at a 20% limited capacity.

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As energy security concerns increase risks for banks, the industry’s “strong” loss-absorbing buffers will help cushion the expected rise in problem lending from current “benign levels”, analysts said. Moody’s in a note dated August 12.

German banks have kept problematic loan levels “very low” while adding reserves and slightly improving already strong capital during the pandemic, Bernhard Held, vice president, head of credit at Moody’s, said in a comment sent. by email. “It gives them a solid starting position to digest problem loan increases,” Tenuous said.

Alert but confident

German Bank‘s corporate loan portfolio is well diversified, with no concentration risk and a high diploma of investment grade companies, CEO Christian Sewing said on a recent earnings call. At the same time, Commerzbank’s capital and supply strength, as well as improving profitability, make it confident in its ability to handle any downturn, CEO Manfred Knof said.

Both banks expect their cost of risk to rise by around 20 basis points of average lending in the event of a gas cut, although neither sees this as a base case scenario. Deutsche’s cost of risk in the second quarter was 19 basis points, or 233 million euros. At Commerzbank, it was 42 basis points, reflecting a risk result of 106 million euros and a separate management hedge of 564 million euros.

The German government could intervene if the situation becomes dire. State support schemes and aid programs through the KfW development bank have proven “very effective” during the pandemic and the same could be expected if Russia gas deliveries were halted, Commerzbank chief financial officer Bettina Orlopp said in an earnings call.

Thomas Groß, CEO of federal state lender Landesbank Hessen-Thüringen, or Helaba, said in a tax return that the bank’s “highly diversified business model” positions it well to weather the impact of energy shortages and high inflation in the remainder of 2022. A spokesperson declined to comment specifically on the scenarios. gas supply.

Diversified books

In a sample of the largest German banks, Bayerische Landesbank, or BayernLB, is the most exposed to vulnerable sectors. Its exposure to the energy sector represented 41% of the total gross credit volume in the corporate portfolio at the end of 2021.

However, more than 60% of the exposure consists of projects focused on renewable energy or energy transition, and the energy portfolio as a whole is “well diversified, spread across the entire value chain and 85% of this one is rated investment grade,” a BayernLB spokesperson said via email. The bank believes that portfolio companies “will be able to manage and survive the current crisis,” the spokesperson said, adding that the bank is in close contact with its customers.

BayernLB’s energy exhibit is an example “suggesting that high-level corporate industry exhibits may not tell the full story of reliance on gas supply”, said Moody’s Held.

Helaba, BayernLB and other countries federal state banks “have strengthened their risk management and are not particularly exposed to possible gas supply rationing,” according to Held.

Federal state banks struggled during the 2008 global financial crisis, but have since restructured. Because there has been so much balance sheet repair in the past, banks are showing good diversification of exposures overall, according to Forster.

Norddeutsche Landesbank, or NordLB, was not available for comment. A spokesperson for Landesbank Baden-Württemberg, or LBBW, said the group could not comment until its results are released Aug. 24.

There is also some regional diversification in banks’ portfolios. Federal state banks, or landesbanken, have more exposure to German-based companies, with BayernLB’s domestic corporate portfolio, for example, accounting for 74.4% of its total corporate portfolio in 2021. Deutsche Bank accounted for about 44% of the total companies. the exposure and that of Commerzbank for about 41%, according to documents filed by the company.

High gas consumption

Industrial consumers and utilities account for more than half of gas consumption in Germany, while households account for 30%, according to BDEW data analyzed by Scope Ratings.

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The chemical sector needs gas the most among industrial consumers, followed by metals and mining, and food processing industries, the data shows.

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Those industrial consumers would likely bear the brunt of any supply cuts because household needs would come first, said Yesenn El-Radhi, vice president of global sovereign ratings at DBRS Morningstar, in an interview. JThis could require state support for businesses, which would strain public finances, El-Radhi said.

Low concentration risk

The impact on banks is expected to come from a general deterioration in the economy and deterioration in consumer confidence, rather than from their direct exposure to gas-dependent industries, Forster said. Sector-specific risk can be manageable.

German chemicals group BASF SE, for example, is heavily dependent on gas in its manufacturing process, but also has an oil and gas subsidiary that benefits from high gas prices. This can, to some extent, compensate for the drop in income, Forster said.

Firms that are struggling are likely to receive help from the federal government, as in the case of Uniper SE, Förster noted. Germany’s largest gas importer said on July 22 that the state would buy a 30% stake in the company for 267 million euros under a 15 billion euro support package.

A recessionary environment will lead to some corporate failures and likely some erosion of bank asset quality. But higher net interest income, driven by higher central bank rates, will mitigate that, Förster said.

German banks expected to rise industry risk benefits from rising rates that many European peers due to their a relatively high reliance on net interest income, analysts at S&P Global Ratings said in a July 19 report.

The probability of default increases

Business payment defaults across the The DACH region – comprising Germany, Austria and Switzerland – as a whole is expected to rise, according to S&P Global Ratings. The agency expects default rates among DACH-based speculative-grade corporate issuers to exceed the projected European average of 3% by March 2023. In 2020 and 2021, the region’s high-yield sector has shrugged off COVID-19 strains and outperformed the global average, with default rates of 1% to 2%, the agency noted.

Building Materials, Internet Retail and Leisure Products were the sectors with the largest year-over-year increases in median one-year default rate probability from market signal to market signal. first half of 2022, according to data from S&P Global Market Intelligence. The rate of increase among industrial conglomerates and metal and mining companies was about five times higher than a year ago, the data showed.

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Consumer discretionary, materials and industrials were the sectors with the highest median default rate probability recorded in the first half of this year, the data showed.

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Corporate loans account for less than half of the total loans of major DACH-based banks with total assets exceeding €50 billion, according to Market Intelligence estimates.

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