Lenders in the European Union lowered their probability-of-default (PD) estimates for corporate borrowers in Q2 for the fourth consecutive quarter.

The mean average weighted PD for corporate exposures, as gauged by EU banks for counterparties across 39 countries, was 2.1% in Q2 2019, down from 2.24% in the previous quarter and 2.43% a year prior. 

The mean average weighted loss-given-default (LGD) estimate was 35.34%, up from 35.16% on the quarter but down slightly from 35.36% on the year.

Corporate PDs ranged from 0.63% for Swedish counterparties to 8.45% for Greek borrowers. LGD values were lowest for Danish corporates, at 22.44%, and highest for Chinese companies, at 47.29%. 

Greek borrower PDs have declined the most of the 39-country sample, having averaged 11.8% in Q1. On the flip side, Italian debtor PDs have increased the most, with an average of 6.6% in Q2, compared with 6.12% in Q1.

Credit risk estimates for retail exposures also improved. The mean average weighted PD for these was 2% in Q2 2019, down from 2.31% three months prior and 2.70% in Q2 2018. 

The mean average weighted LGD estimate for retail exposures was 26.09%, down from 26.28% in Q1 2019, but up from 25.49% in Q2 2018. 

Swedish retail borrowers attracted the lowest average weighted PD estimates, at 0.36%, and Greek borrowers the highest, at 17.6%. Retail LGD percentages were lowest for Maltese debtors, at 8.72%, and highest for Indian debtors, at 52.17%.

Slovakian retail borrowers saw their PDs decline by the greatest extent among the 39 countries, to 1.27% in Q2 from 15.1% the quarter prior. Greek retail borrowers’ PDs increased the most, to 17.6% from 14.98%.

What is it?

The European Banking Authority produces quarterly credit risk parameters, based on data provided by EU banks that use internal-ratings based approaches. The disclosure is intended to increase transparency on the default rate, loss rate, PD and LGD of the retail and corporate counterparties of EU banks. 

PDs are computed as a weighted average of non-defaulted exposures. Only statistics for countries with more than three banks reporting in that particular country are shown.

Why it matters

Borrower PDs and LGDs have a two-fold significance to banks. Firstly, they’re used to generate risk-weighted asset values for credit assets, which determine their associated capital charges. Secondly, they’re used as one input to set loss provisions under accounting standard IFRS 9.

Assets with high PDs and LGDs imply higher regulatory capital charges and provisions, making them expensive for banks to hold.

Various factors affect a borrower’s creditworthiness, including their national economic context – hence why Greek counterparties exhibit high PDs and LGDs. By the same token, though, improvements to a country’s economic outlook can filter through to the credit profiles of their corporate and retail borrowers. Again, this may explain why the credit parameters for Greek borrowers have improved in recent quarters as the country’s economy has recovered from the tumult of the eurozone crisis.

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