News


30/01/2017


Flagstone Bank Credit Update 30 Jan 2017

Headlines:
  • The first estimate figure from the Office of National Statistics indicates that the UK economy grew faster than expected for the final quarter of last year by 0.6% and by 2.0% for 2016 as a whole.
  • The influential EY Item Club warns that the UK economy will see three years of relatively slow growth, predicting that higher inflation will result in GDP growth of 1.3% in 2017 and of just 1.0% in 2018.
  • The EY Item Club expects inflation to rise to 3.1% by the final quarter of 2017, before easing back to 2.0% by the end of 2018, while unemployment was likely to jump to more than 6.0% by the end of 2018.
  • UK government borrowing fell by £0.4bn in December to £6.9bn when compared with 2015 while the borrowing total for the year was £63.8bn which is £10.6bn lower than for the same period a year ago.
  • The U.S. economy expanded at its slowest pace in five years in 2016 as an unexpectedly sharp fall in exports dragged down growth in the final quarter to 1.9%, resulting in the U.S. economy expanding by 1.6% in 2016.
  • RBS intends to apply a £3.1bn provision as it prepares to settle significant claims in the U.S. of up to £9.0bn that it mis-sold toxic mortgage-backed securities in the run up to the 2008 financial crisis.
  • The Bank of England is considering a further intervention into the Co-operative Bank that could lead to the lender being wound up which could potentially ‘wipe-out’ bondholders under current ‘bail-in’ rules.
  • The FTSE 350 Bank Index rose by 1.7% over the week to 4,364 on anticipation of strong final quarter financial results from major banks despite fears of an adverse impact of U.S. isolationist trading policies.
  • The ITRAXX Europe Senior Financials 5-year CDS Index improved by 1.7% over the week to 85bps as markets continue to react positively to the encouraging eurozone economic signs.

General Commentary:

The official first estimate figure from the Office of National Statistics (ONS) indicates that strong consumer spending helped the UK economy to grow faster than expected for the final quarter of last year. Gross domestic product (GDP) grew by 0.6% in the October-to-December period, the same rate as in the previous two quarters. The figure indicates that the feared economic slowdown following the Brexit vote has not materialised. For 2016 as whole, the economy grew by 2.0%, down from 2.2% in 2015. The quarterly growth figure was slightly better than the 0.5% rate that most economists had expected. The dominant services sector – which accounts for about three-quarters of the UK economy – grew by 0.8% in the quarter, helped by growth in the distribution, hotels and restaurant industry. Retail sales and travel agencies also supported growth in this sector. The figures also showed that the construction industry grew by 0.1% and agriculture by 0.4%, while industrial production was unchanged.

Despite the encouraging GDP figures the influential EY Item Club warns in its latest forecast that the UK economy will see three years of relatively slow growth as it comes to rely more on trade and less on consumer spending. The forecast predicts that higher inflation caused by a weaker pound would result in GDP growth of 1.3% in 2017 (and just 1.0% in 2018) but that rising demand for exports would offset some of the growth.

The EY Item Club also expects inflation to rise to 3.1% by the final quarter of 2017 before easing back to 2.0% by the end of 2018. On top of this, it said unemployment was likely to jump from 4.8% in the final quarter of last year to more than 6.0% by the end of 2018. The think tank believes that while the mix of these factors is expected to have a knock-on impact on consumer spending as growth in disposable incomes is eroded, a weaker pound and a softer domestic market were likely to encourage higher levels of UK exports as businesses seek income opportunities overseas. As such, it expects exports to increase by 3.3% this year and by 5.2% in 2018.

Official figures from the ONS show that UK government borrowing fell by £0.4bn in December to £6.9bn when compared with 2015. The figures mean that the borrowing total for the year is £63.8bn which is £10.6bn lower than for the same period a year ago. The last Autumn Statement indicated that the government would borrow £68.0bn over the full financial year to the end of April 2017. The government typically receives more money than it spends in January, when a high number of tax bills are paid. The ONS revised the borrowing figure for November down from £12.6bn to £11.3bn which will help the Chancellor to keep to the Autumn Statement target. However even if met, the deficit will still represent a challenging 3.5% of economic output – albeit down from 10% six years ago.

The U.S. economy expanded at its slowest pace in five years in 2016 as an unexpectedly sharp fall in exports dragged down growth in the final quarter. GDP in the world’s largest economy grew at an annual rate of 1.9% in the final three months of 2016, lower than the 2.2% forecast by economists. It meant that overall the U.S. economy expanded by 1.6% in 2016. Net foreign trade dropped sharply in the fourth quarter which wiped 1.7% off the headline GDP figure and resulted in the biggest negative impact for six and a half years. Despite the headline GDP figure coming in weaker than expected economists were optimistic about the underlying data, suggesting that there was enough momentum to accelerate growth to 2.7% this year.

The Royal Bank of Scotland (RBS) intends to apply a £3.1bn provision to its fourth quarter financial accounts as it prepares to settle significant claims in the U.S. that it mis-sold toxic mortgage-backed securities in the run up to the 2008 financial crisis. The provision means that RBS is unlikely to make a profit in 2016 for the ninth straight year. RBS is preparing to start negotiations with the U.S. Department of Justice over a settlement of the mis-selling claims, the timing of which is still uncertain. This is the first time that RBS has set aside any money to directly cover a settlement with the U.S. Department of Justice over the alleged decades-old mis-selling of mortgage-backed securities. Investors and the markets have welcomed the first signs of clarity over the eventual size of RBS’s settlement even as the final total remains unclear. As a result the share price is up by 5% over the week while the 5-year CDS spread improved by 12% to 99bps. However analysts are speculating that the bank could have to pay the U.S. Department of Justice as much as £9.0bn in the next few months while even the lowest estimate of £2.0bn would make it the largest fine in the bank’s history.

It is understood that the Bank of England is considering a further intervention into the Co-operative Bank that could lead to the lender being wound up before the end of the year. The bank warned investors in a brief statement last week that it was set to fall short of the capital targets it had agreed with the regulator. The bank’s executive team is now scrambling to submit a new restructuring plan to the Bank of England to buy more time. However, analysts point to the repayment of a £400m bond due this September that could complicate matters. Although the bank has sufficient cash to repay the bond it is felt that it will struggle to raise a new bond on acceptable terms to replenish its finances.

Analysts predict that rather than let the bank make the debt repayment and then struggle to find new capital, the Bank of England’s Prudential Regulation Authority may choose to find an alternative solution. The bank’s recovery plan depended on a widely held assumption at the time that interest rates would have started to rise by now. A wind-down of the lender could potentially wipe out bonds and mark the first rescue of a high street bank since RBS and HBOS were nationalised in 2008. It would also mark the first test case for the Bank of England’s new rescue powers which were introduced in the aftermath of the financial crisis. Under the so-called ‘bail-in’ rules, bondholders must at least take a financial ‘hit’ before a taxpayer-backed rescue is permitted. Deposits of up to £85,000 would be safeguarded, however, under the Financial Services Compensation Scheme.

See below for 5-year CDS spread and share price movements for the last week.
5-YEAR CDS SPREADS AND SHARE PRICES
Movements over the Last Week
Date: 30th January 2017
5-Year CDS Spreads (bps) Equity Share Prices
27-Jan-17 20-Jan-17 Chg 27-Jan-17 20-Jan-17 Chg
ABN Amro Bank N.V.
ABN AMRO Groep N.V. 75 74 +1.4% 22.00 22.38 -1.7%
Parent: Aldermore Group plc
Aldermore Bank plc n/a n/a n/a 2.14 2.19 -2.3%
Irish Sovereign
Allied Irish Banks 64 64 0.0% 4.99 4.92 +1.4%
Parent: Arbuthnot Banking Group plc
Arbuthnot Latham & Co. n/a n/a n/a 14.90 14.83 +0.5%
Aust and NZ Banking Group Ltd 61 65 -6.2% 29.77 29.40 +1.3%
Banco Bilbao Vizcaya Argentaria S.A. 109 122 -10.7% 6.38 6.12 +4.2%
Parent: Barclays plc
Barclays Bank plc 76 82 -7.3% 2.31 2.27 +1.8%
BNP Paribas S.A. 77 83 -7.2% 61.45 60.06 +2.3%
Parent: Close Brothers Group plc
Close Brothers Limited n/a n/a n/a 14.41 14.46 -0.3%
Credit Agricole S.A. 67 72 -6.9% 12.48 12.39 +0.7%
Parent: Credit Suisse Group AG
Credit Suisse AG 108 116 -6.9% 15.28 15.55 -1.7%
Deutsche Bank AG 156 156 0.0% 19.18 18.06 +6.2%
Parent: HSBC Holdings plc
HSBC Bank plc 63 69 -8.7% 6.88 6.78 +1.5%
Parent: ING Groep N.V.
ING Bank N.V. 59 62 -4.8% 13.66 13.36 +2.2%
Intesa Sanpaolo S.p.A. 128 127 +0.8% 2.27 2.47 -8.1%
Parent: Investec plc
Investec Bank plc n/a n/a n/a 5.75 5.66 +1.6%
Parent: Lloyds Banking Group plc
Lloyds Bank plc 65 70 -7.1% 0.66 0.65 +1.5%
Metro Bank plc n/a n/a n/a 32.90 31.70 +3.8%
Nationwide Building Society 80 80 0.0% n/a n/a n/a
Nordea Bank AB 48 65 -26.2% 106 104 +1.9%
Parent: RBS Group plc
Royal Bank of Scotland plc 99 113 -12.4% 2.32 2.21 +5.0%
Ult. Parent: Banco Santander S.A.
Santander UK plc 81 81 0.0% 5.36 5.13 +4.5%
Shawbrook Group plc n/a n/a n/a 2.41 2.42 -0.4%
Societe Generale 76 82 -7.3% 47.37 45.84 +3.3%
Parent: Standard Chartered plc
Standard Chartered Bank 92 107 -14.0% 7.82 7.53 +3.9%
Svenska Handelsbanken AB 43 55 -21.8% 133 129 +3.1%
Unicredit  S.p.A. 155 164 -5.5% 27.71 26.90 +3.0%
FTSE 350 BANK INDEX n/a n/a n/a 4364 4292 +1.7%
SNR FIN ITRAX CDS 5-YEARS    (ESTIMATED) 85 86 -1.7% n/a n/a n/a

 

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