As the sun sets on the COVID-19 pandemic, collateral damage is being assessed. The impact on businesses has varied drastically: some failed while others flourished. An analysis of Lithuanian banks reveals how financial institutions navigated the tough times, and offers insight into preparedness for the recovery of the economy and associated challenges.
According to data sourced from the Bank of Lithuania, Lithuanian banks earned EUR 74.9 million net profit in Q1 2021, an impressive increase of EUR 10 million on the previous year. Overall, banks operated profitably, however 25 percent reported losses due to their business activity being relatively new in the market. It should be noted that the reported jump in profit is attributed to the recovery of loan impairments, rather than income from interest or fees.
While income from the main activities remained stable and administration costs increased efficiency, ratios became inferior. Historically, banks operating in Lithuania have the best cost-to-income ratio in the EU. This leading position may be under threat, however, as during the year the ratio increased from 50.8% to 63.4%. Stable income and higher costs also had a negative impact on return on assets and return on equity which fell by - 0.05 p.p. (to 0.79%) and – 1.29 p.p. (to 9.77%) respectively.
The COVID-19 pandemic saw most companies postpone long-term investments, and receive financial support from the government. These factors contributed to a reduction in demand for banking loans in the corporate sector. Additionally, banks were reluctant to finance risky business ventures, such as restaurants and hotels. The loan portfolio to non-financial corporations experienced shrinkage of 14.5% over the year (Q1 2020 – Q1 2021).
Households also reduced spending, and demand for consumer loans decreased. Mortgages provided a strong counterweight to the overall decline in the loan portfolio. Annual growth of such loans was close to 9.5% and was one of the fastest in the EU, however was not enough to sustain portfolio growth and increase income.
Excess liquidity had a negative impact on profitability results. Deposits in the central bank increased by 80% (to EUR 13.6 billion) over the year, while funds at credit institutions more than doubled. Given that interest rates on such deposits are negative, excess liquidity generated costs rather than income.
Despite the higher credit risk, banks ensured a sustainable capital adequacy ratio as the majority followed ECBs recommendation of not distributing dividends, and setting limits for the payment of dividends from the accumulated 2019-2020 profit. Instead, a large portion of the profit was used to strengthen capital.
Banks operating in Lithuania had the highest liquidity coverage ratio (LCR) in the EU. Due to one-off cash flow redistribution in several banks, it fell from 743% to 463%, but it is still more than four times higher than minimum set. Moreover, customer deposits continue to grow while lending is still relatively slow, allowing banks to increase their liquid assets.
Stable income, profitable activity, strong liquidity and sufficient capital reserves show that banks successfully withstood the challenges of COVID-19, and are well prepared for further business development. However, some issues remain.
The real estate sector has been flagged as potentially problematic. Real estate prices increased by 10% over the year and began to exceed the growth of wages. The upward movement of mortgages is one of the fastest in the EU. However, responsible lending standards and more conservative credit risk policies offer some comfort that there will not be a repeat of the 2008-2009 scenario in Lithuania.
Non-performing loans (NPLs) are also likely to be of concern. According to Bank of Lithuania data, in Q1 2021, non-performing loans contained 2.05%, which is 0.16 p.p. less than year ago. However, the share of loans overdue up to 90 days is increasing. To support customers that contracted COVID-19, banks postponed payments. There will be no such support after pandemic, potentially leading to a significant increase in NPLs. Many zombie companies are continuing activity only because they receive governmental financial support or funding from banks. It is expected that a large number of these companies will collapse when governmental support ends, further increasing NPLs.
These predictions are based on market analysis and experience. The true outcomes will be known in the coming months, however we can take comfort in the strong position of Lithuanian banks.