Financial Institutions Face Ongoing COVID Threat

Ratings firm Fitch has said the global financial institutions with the majority of firms set to be impacted.

The firm has assessed the rating vulnerabilities of global financial institutions (FIs) during a coronavirus downside scenario and assigned vulnerability scores to the major FI sub-sectors to show their potential sensitivity to a severe coronavirus downside scenario.

The report shows rating vulnerability scores under the downside scenario for each sub-sector on a scale from ‘1’ (virtually no impact, no rating changes) to ‘5’ (high impact, most or all ratings negatively affected).

The report found the majority of FI sectors in North America, EMEA, APAC and LATAM are assigned a score of ‘3’ (medium impact) and ‘4’ (medium to high impact), due to the prolonged nature and severity of the downside scenario. It added Heavy Outlook and Rating Watch activity are probable for about 77% of FI issuers, as well as numerous ratings changes.

“Rating downgrades are viewed as most likely under a score of ‘5’, which is assigned to larger LATAM banks, European Global Trading and Universal Banks, aircraft lessors globally and US- and APAC-based private-equity collateralised fund obligations. LATAM emerges as the most vulnerable region, due to the large number of LATAM sovereigns with negative outlooks, which are therefore exposed to further potential negative sovereign actions,” said the report. “We are continuously updating our assumptions and ratings under our central baseline scenario, with special reports issued that summarise the key regional rating actions taken. The baseline scenario assumes a short but severe global recession with recovery starting in 3Q20 as the coronavirus crisis subsides.

In terms of insurers the report found the life sector would be most exposed to capital market volatility under the downside scenario, due to high asset leverage.

“We incorporate an assumption under our stress case of a high yield bond default rate of 22% during 2020 and 2021 (with spreads widening by 600bp), a decline in major stock market indices by 60%, and a drop in 10-year government interest rates by close to half 2019 levels in several countries,” it stated. “We also assume a COVID-19 infection rate of 15% and death rate of 0.75% (of the infected), which could notably impact 2020 earnings due to higher life claims. Furthermore, longer-term downward interest rate pressures would hurt earnings and increase the risk of reserve increases on longer duration products.”

In contrast, non-life insurers and reinsurers have lower investment leverage than life insurers, pointing to a medium impact risk for the risk.

It added some issuers in this sector do hold material levels of equities and other risky assets to capital and are exposed to capital market volatility. However, most have good capital buffers, allowing for many to absorb even the high 60% stock decline under our severe downside scenario.

“Exposure to insured claims is generally more modest and focused on more specialised lines such as event cancellation or trade credit,” added the report. “Business interruption (BI) claims will be largely mitigated by pandemic exclusions, and the typical need for a property damage trigger. However, while outside even our severe scenario, there is a risk of legislation that attempts to retroactively expand BI coverages. If enacted, this could be a significant negative credit event. Reinsurers will have exposure to ceded mortality claims from life insurers.”