The medium-term outlook for the Baltic countries banking system has been dropped from ‘stable’ to ‘negative’, Moody's Investors Service aid in its latest report, based mainly on the upcoming implementation of a bail-in regime across Europe.
The rating agency said that the 12-18 month outlook forecasts negative credit implications that outweigh the positive developments within that banking system, such as robust economic growth, declining problem-loan levels and stable profitability prospects for the banks.
The Bank Recovery and Resolution Directive (BRRD) establishes a new framework for managing troubled banks in the European Union (EU). The new framework has negative credit implications that exceed the benefits of improved stability for senior unsecured creditors of EU banks, including Baltic banks.
"Aside from the fundamental changes in the EU bank regulatory environment, we acknowledge that strengthening economic fundamentals in each country are benefiting Baltic banks' credit profiles," said Jan Skogberg, a Moody's analyst.
"We expect greater credit demand and stronger loan growth, which, together with a likely increase in interest rates towards the end of this outlook period, should provide a boost to bank profitability in the region. Already, loan growth in Estonia and Lithuania has turned positive entering 2014 and is likely to turn positive in Latvia during the outlook period due to the extended economic recovery," added Skogberg.
Moody's also said that asset quality will improve in all three Baltic countries as their economies and housing markets continue to recover. Corporate problem loan ratios will likely decline faster than household loans because corporate operating conditions have improved much faster than household conditions.
Moody's expects future asset quality improvements to be greatest in Latvia and Lithuania, where problem loans remain elevated, whereas in Estonia NPLs are already low compared with NPL peaks in 2010. Indeed, corporate NPLs are almost comparable with Nordic countries, where asset quality is consistently strong.
Banks in the Baltic countries are well capitalised and the Moody's base case assumption is that lower impairment charges and recovering profitability will act to strengthen the banks' capital levels.
Furthermore, banks' funding profiles will likely remain stable over the outlook period, as they become less reliant on external funding, including that supplied by Nordic parent groups. The region's deposit base has proved to be sticky and resilient despite the fact that a significant proportion of it is sourced from non-residents located in regions where geopolitical risks persist. Of all deposits in Latvia, 48% (at 30 June) come from non-resident customers and of these deposits, 90% can be withdrawn on demand.
