DBRS Morningstar: COVID-19 Impact Mitigated by Spain’s Recent Economic Momentum

The government in Spain is adopting various measures to slow the spread of the Coronavirus Disease (COVID-19). While these measures will have a negative impact on the economy and people’s lives, this is a positive step towards limiting the impact of the virus on Spain. Over the last week, the number of cases of the Coronavirus Disease (COVID-19) has increased very rapidly in Spain to more than 4,200, as of 13 March. Over a half of the cases are concentrated in the Madrid region, followed by the Basque Country, and Catalonia, and at the moment there is a risk it could become more widespread. The evolution and spread pattern of infected cases mostly resembles the situation in Italy.

Faced with a difficult trade-off between slowing the pace of contagion and minimising the economic impact, the government’s targeted measures have fallen short of a complete lockdown so far, but nonetheless will take a significant toll on activity in the short-term. Furthermore, the Spanish authorities could impose even more restrictive measures following Prime Minister Sánchez’s announcement of the state of emergency coming into force as of March 14 for at least 15 days. This will allow the government to limit the movement of people, intervene in industries or temporarily requisition goods, among other things.

“DBRS Morningstar expects the greatest impact to fall on the tourism and manufacturing sectors. We will continue to assess the extent to which the effect will be transitory and followed by a rebound, or be more permanent, which would negatively affect fiscal and debt metrics”, said Javier Rouillet, DBRS Morningstar Lead Analyst on Spain. “The Spanish economy, unlike most of its European peers, is benefitting from positive growth momentum, a positive credit factor. The country is therefore entering this period of high uncertainty on a more solid economic footing than other eurozone countries”, added Javier Rouillet. GDP growth stood at 2.0% in 2019, with a relatively strong Q4 leaving a carry-over effect of 0.7% for 2020.

The growth outlook in 2020 is subject to significant downward risks from the impact of the virus and the government’s measures on manufacturing, trade, tourism, and the leisure sector overall. DBRS Morningstar considers that these sectors will be the most affected by the supply disruptions and the expected reduction in external and domestic demand. The supply disruptions, temporary halts to production, and the anticipated global slowdown will hit the industrial sector (15.7% of GDP in 2019) in the short term. Depending on when the pandemic levels off in Spain, a gradual resumption to normal levels of activity is likely to ensue. The potential impact on the tourism sector from the restrictions, including travel bans and the temporary closure of shops, as well as lingering fears, might hold back tourist demand for longer, probably at least a few months. The tourism sector is an important growth driver of the Spanish economy with an overall contribution of 12-13% to GDP and employment in 2018, including the indirect impact of tourism-related activities.

The high share of temporary contracts - 26% of total workers -, one of the highest in the euro area, might amplify the negative effect on households and consumer demand. Given the importance of small and medium-size enterprises (SMEs) in Spain, the recently announced measures to ease the financial stress that the private sector might face in coming weeks will be critical in containing the impact. Additional measures may be needed to help households cope with loss of income for temporary workers that are not covered by current socials safety nets.

On Thursday, the Council of Ministers approved a targeted fiscal package worth around EUR18 billion to boost the healthcare system and mitigate the economic impact. The main measures are: (1) allowing SMEs and self-employed workers to postpone tax payments by six months, de facto providing EUR 14 billion in near term cashflows, (2) EUR 3.8 billion of additional funds to strengthen the healthcare system’s response, (3) targeted Instituto de Crédito Oficial’s credit lines worth EUR 400 million to support the tourism, hospitality, and transport sectors. Earlier this week, the authorities improved the benefits to be received by workers isolated and/or infected with COVID-19.

“The sharp deleveraging of the private sector in recent years, the targeted policy response to ease conditions for households and firms at risks, and the ECB´s further relaxation of monetary policy should help it absorb the temporary financial impact from COVID-19,” said Javier Rouillet. In this regard, DBRS Morningstar will be looking for information on whether the virus spread is levelling off in Spain and other countries, the extent of the damage to Spain’s economy and employment levels, and the speed at which business activities can get back to normal.

The 2020 fiscal deficit target of 1.8% of GDP approved by the government now appears very ambitious, even if the measures to enhance fiscal revenues are passed with a 2020 Budget. A steeper deceleration of activity than originally anticipated, the activation of automatic stabilisers, and extraordinary fiscal measures to limit the economic impact of COVID-19 will put additional strain on the fiscal accounts in 2020. Therefore, DBRS Morningstar considers that it will be important for the Spanish government to follow a two-pronged approach on the fiscal side, complementing the short-term extraordinary measures to respond to COVID-19 with a firm commitment to continue its fiscal consolidation efforts in the medium term.

COVID-19 to Weaken Spanish Banks Profitability and Asset Quality

DBRS Morningstar expects the Spanish banking sector to be negatively affected by COVID-19, as will the rest of the European Banking Sector. We expect Spanish banks' profitability to weaken from 2019 levels with pressure on net interest margins likely to intensify and new lending volumes to be lower than initially anticipated. Impairment charges will increase, reflecting lower economic forecasts in impairment models and weakening asset quality. Liquidity pressures are likely to increase as disruptions to the normal course of business mean that more companies and financial institutions face increased volatility in their cashflows and the need to shore up this finances.

We highlight the following areas of concern:

Impact on credit quality: Given the current trajectory, we expect a spike in asset quality problems, particularly in SMEs, as these companies are the most vulnerable given that their financial situation it is usually tighter than other companies. According to the EBA transparency exercise, SME exposures for the largest Spanish banks range from 6.8% (Kutxabank) to 27.9% (Cajamar), with an average of 16.5%.

Impact on credit flows: We expect a negative impact across all sectors. However, we think household mortgages and consumer lending will be affected the most as buying decision will be postponed. Corporate and SME lending will also be negatively affected, but partly mitigated by new liquidity measures and credit lines provided by public or private banks. For instance, BBVA (EUR 25 billion), Caixabank (EUR 25 billion) or Santander (EUR 20 billion) have all announced that they have significant funds available for SME lending. In addition, the recent ECB measures provide sufficient liquidity for banks to grant SMEs loans.

Impact on new Loan Loss Provisions (LLPs): Impairment charges will increase given that LLPs are now calculated using IFRS9 accounting standards, in which economic scenarios are the basis for calculating impairment charges. For instance, Banco Santander used an average GDP growth over an 5 year horizon of 1.57% for its Spanish business in order to calculate LLPs at end-2019. All economic scenarios used for banks will need to be reviewed.

“DBRS Morningstar considers Spanish banks have plenty of liquidity to grant SME loans in order to partly offset the negative implications of the recent outbreak of the COVID-19. However, in order to make these funds available in full it would be important for the European or Spanish authorities to give public guarantees to cover credit losses at the banks”, said Pablo Manzano, from DBRS Financial Institutions team.

The press release titled “COVID-19 Impact Mitigated by Spain’s Recent Economic Momentum” is available at www.dbrs.com.

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