U.S. banks are expected to suffer significant deterioration in asset quality due to the economic fallout from Covid-19, but Fitch Ratings says the damage will take time to reveal itself amid government efforts to shore up the economy.
In a new report, the rating agency suggested that the true toll of the pandemic on bank balance sheets won’t be immediately evident due to regulatory relief and other measures designed to ensure that credit continues to flow despite the market turmoil.
For instance, Fitch said that reporting standards for banks have been relaxed, “which means that impaired loans and troubled debt restructures could be understated in the near term.”
Fitch said that the recognition of impaired loans will likely be delayed for several quarters, and potentially into 2021.
Additionally, Fitch said that forbearance programs could have the effect of artificially inflating bank earnings in 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.”
However, if the borrower ends up defaulting once the forbearance period ends, banks will then face losses that were not reported in earlier periods.
Alongside earnings and loan losses, measures designed to boost lending could also end up inflating reported regulatory capital ratios, Fitch said.
The rating agency cautioned that the delay in revealing the true effects of the pandemic on banks could pose secondary risks for the banks too.
“The sheer scale of coronavirus relief measures poses reputational risks for banks if mishandled or implementation is poor,” said Michael Shepherd, director at Fitch.
“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,” Shepherd noted.