• Although the CDS market reacted to the Brexit decision, with the ITRAXX Europe Senior Financials 5-year CDS Index spiking to a level of 135bps, it has now returned to its pre-Brexit level of 96bps.
• S&P and Fitch downgrading the UK’s sovereign credit rating with S&P stripping the UK of its last remaining top-notch credit rating by dropping it to “AA”.
• The BoE took action to mitigate the risk of increased funding costs that might discourage lending by lowering the capital amount banks are required to hold in reserve, freeing up an extra £150 billion.
• Moody’s cut its outlook on the UK banking system to ‘Negative’ as well as the outlooks on the ratings of 12 UK banks and building societies.
• The so-called “challenger” banks have also been adversely affected by the negative sentiment after the Brexit decision, owing to their exposure to the UK retail market and SME businesses.
• Despite a majority of economists, analysts and lenders predicting a cut to the base rate, the Monetary Policy Committee (MPC) defied expectations and voted to maintain the rate at 0.5%.
• The BoE has warned that the economic aftershock of the Brexit decision could last up to 3-years, raising expectations that the Bank will launch a significant stimulus programme at its August policy meeting.
• The EY Item Club has cut its growth estimate for this year to 1.9% from 2.3% predicted in April while it expects the economy to grow by only 0.4% next year against 2.6% previously.
• Both Canada and Australia have indicated that they would like to move forward quickly to establish formal trading links with the UK by negotiating free trade deals.
What a momentous last month this has been in the aftermath of the Brexit decision to leave the European Union (EU). Given that 3 weeks has passed, we thought it might be useful to provide below a recap of the main credit-related events.
As most analysts had forewarned, there was an element of market panic when the unexpected Brexit decision was announced. The 5-year credit default swap (CDS) market reacted immediately with the ITRAXX Europe Senior Financials 5-year CDS Index spiking to a level of 135bps from 95bps. However, unlike the global financial crisis, most global banks are understood to be well prepared for any market disruption with capital buffers significantly higher and balance sheets in a much more conservative state. As a consequence, the Index has now returned to its pre-Brexit level of 96bps.
The credit rating agencies also reacted to the Brexit decision with Standard & Poor’s and Fitch downgrading the UK’s sovereign credit rating. Standard & Poor’s stripped the UK of its last remaining top-notch credit rating, dropping it by two grades from “AAA” to “AA”. This is the first time S&P had reduced an AAA-rated sovereign credit rating by two notches in one move. Fitch also downgraded the UK’s creditworthiness by one notch while Moody’s applied a ‘Negative’ outlook. All three rating agencies have indicated that more cuts could follow.
The Bank of England (BoE) took decisive action to mitigate the risk that the UK sovereign rating downgrade may increase wholesale funding costs for UK banks and discourage lending for now by lowering the amount of capital banks are required to hold in reserve, freeing up an extra £150 billion for lending. The BoE also signalled that it may reduce the UK base rate in August to a historic low of 0.25% and that a return to quantitative easing (QE) is also under review as well as the possibility of an extension of the Funding for Lending Scheme (FLS) which provides cheap finance for major lenders in an attempt to get credit flowing.
Also in reaction to the Brexit decision, Moody’s cut its outlook on the UK banking system to ‘Negative’ as well as the outlooks on the ratings of 12 UK banks and building societies. The 12 banks and building societies affected are: Barclays Bank, HSBC Bank, Santander UK, Coventry Building Society, Leeds Building Society, Lloyds Bank, Nationwide Building Society, Nottingham Building Society, Principality Building Society and TSB Bank as well as Bradford & Bingley and NRAM (No1) Ltd. The ratings of four other UK banks and building societies were maintained namely: Royal Bank of Scotland Group plc, Skipton Building Society, West Bromwich Building Society and Yorkshire Building Society as Moody’s believes that the potential impact of the referendum result on these institutions is outweighed by more firm-specific credit considerations.
Standard & Poor’s also reaffirmed current long-term credit ratings for a number of major banks but has applied “Negative” outlooks to Barclays Bank plc, Clydesdale Bank plc, HSBC Bank plc, Lloyds Bank plc, Santander UK plc and the major Australian banks.
Although not credit-rated, the so-called “challenger” banks have also been adversely affected by the negative sentiment after the Brexit decision, owing to their exposure to the UK retail market and SME businesses. This has resulted in a significant fall in the share prices of many “challenger” banks that are listed. Shawbrook Group surprised the market by announcing that it expects to book an additional impairment charge of £9.0 million in the second quarter due to some irregularities in its asset finance business. However, analysts remain confident that provided all irregularities have been identified, this should not cause lasting damage to their reputation.
Despite a majority of economists, analysts and lenders predicting a cut to the Base Rate, the Monetary Policy Committee (MPC) defied expectations and voted to maintain the rate at 0.5%. The MPC’s post-meeting report indicated that the MPC voted by a majority of 8-1 to maintain Bank Rate at 0.5% with one member voting for a cut in Bank Rate to 0.25%. Expectations of a rate cut were so high that mortgage lenders had begun to price it into their products by dropping interest on fixed rate deals to record lows and increasing their tracker rates. Analysts now expect a Base Rate cut to happen when the MPC meets in August.
Andy Haldane, chief economist at the BoE has stated in a speech that the BoE must act “promptly as well as muscularly” next month with a package of measures to cushion the blow from Brexit as he warned that the economic aftershock could last up to three years. This has been interpreted by analysts as a clear sign to the markets that the BoE will launch a significant stimulus programme at its August policy meeting. His view is that it would be better to take a “sledgehammer” to shore up confidence than “a miniature rock hammer”. His comments mean that three of the MPC’s nine rate-setters have publicly supported taking decisive central bank action in August.
It is widely reported that an influential forecaster is expected to issue a pessimistic report this week which warns that Brexit could result in a ‘permanent’ reduction in growth. The EY Item Club, which uses the same economic model as the Treasury, now expects the economy to slow to a crawl next year. It is understood that it has cut its growth estimate for this year to 1.9% (from 2.3% predicted in April) while it expects the economy to grow by only 0.4% next year, against 2.6% previously. It argues that heightened uncertainty is likely to hold back business investment, while it believes that consumer spending will be restrained by a weaker jobs market and higher inflation.
Monthly data due to be published this coming Friday by Markit is expected to show that growth in the UK economy has either ground to a halt or has gone into reverse since last month’s EU referendum vote. Surveys of activity in manufacturing and services are expected to provide some of the earliest evidence of a post-referendum slowdown. Economists expect both sectors to have contracted since the start of this month, having grown modestly in June, as the aftermath of the vote hits confidence and business investment.
On the positive side, both Canada and Australia have indicated that they would like to move forward quickly to establish formal trading links with the UK by negotiating free trade deals. Significantly, Canada indicated that it was likely to offer the same terms as recently agreed with the European Union (EU) while Liam Fox, the International Trade Secretary, announced that he was already “scoping about a dozen other free trade deals”.
|5-YEAR CDS SPREADS AND SHARE PRICES|
|Date:||20th July 2016|
|5-Year CDS Spreads (bps)||Equity Share Prices (LCL)|
|Parent: Aldermore Group plc|
|Aldermore Bank plc||n/a||n/a||n/a||1.41||1.91||-26.2%|
|Allied Irish Banks||71||73||-2.7%||6.40||6.30||+1.6%|
|Parent: Arbuthnot Banking Group plc|
|Arbuthnot Latham & Co.||n/a||n/a||n/a||14.24||15.97||-10.8%|
|Aust and NZ Banking Group Ltd||84||86||-2.3%||24.85||23.23||+7.0%|
|Banco Bilbao Vizcaya Argentaria S.A.||134||164||-18.3%||5.35||5.40||-0.9%|
|Parent: Barclays plc|
|Barclays Bank plc||125||131||-4.6%||1.50||1.66||-9.6%|
|BNP Paribas SA||77||96||-19.8%||42.78||43.45||-1.5%|
|Parent: Close Brothers Group plc|
|Close Brothers Limited||n/a||n/a||n/a||11.34||12.41||-8.6%|
|Credit Agricole SA||76||93||-18.3%||7.84||8.05||-2.6%|
|Parent: Credit Suisse Group AG|
|Credit Suisse AG||144||154||-6.5%||21.53||20.55||+4.8%|
|Deutsche Bank AG||213||209||+1.9%||13.02||13.68||-4.8%|
|Parent: HSBC Holdings plc|
|HSBC Bank plc||83||106||-21.7%||4.79||4.31||+11.1%|
|Parent: ING Groep N.V.|
|ING Bank N.V.||66||87||-24.1%||9.78||9.98||-2.0%|
|Intesa Sanpaolo S.p.A.||144||161||-10.6%||1.93||2.04||-5.4%|
|Parent: Investec plc|
|Investec Bank plc||n/a||n/a||n/a||4.49||4.49||0.0%|
|Parent: Lloyds Banking Group plc|
|Lloyds Bank plc||118||109||+8.3%||0.56||0.65||-13.8%|
|Metro Bank plc||n/a||n/a||n/a||18.97||20.60||-7.9%|
|Nationwide Building Society||100||78||+28.2%||n/a||n/a||n/a|
|Nordea Bank AB||67||70||-4.3%||73||76||-3.9%|
|Parent: RBS Group plc|
|Royal Bank of Scotland plc||135||142||-4.9%||1.84||2.22||-17.1%|
|Ult. Parent: Banco Santander S.A.|
|Santander UK plc||87||80||+8.8%||3.81||3.81||0.0%|
|Shawbrook Group plc|
|Shawbrook Bank Limited||n/a||n/a||n/a||1.67||2.40||-30.4%|
|Parent: Standard Chartered plc|
|Standard Chartered Bank||123||169||-27.2%||6.00||5.26||+14.1%|
|Svenska Handelsbanken AB||64||70||-8.6%||104||100||+4.0%|
|FTSE 350 BANK INDEX||n/a||n/a||n/a||3164||3145||+0.6%|
|SNR FIN ITRAX CDS 5-YEARS||96||115||-16.5%||n/a||n/a||n/a|