News


19/06/2017


Flagstone Bank Credit Update 19 June 2017

Monthly Headlines:
  • Moody’s has warned that the UK’s sovereign credit rating could be downgraded after the UK general election delivered a hung parliament which could slow the drive to reduce the UK budget deficit.
  • Although the MPC voted to leave UK interest rates unchanged at their current record low of 0.25% there was a surprise 5-3 split among members which could result in a rate increase to 0.50% in August.
  • UK prices are rising at their fastest pace in almost four years with inflation reported at 2.9% for May which was above economist expectations of 2.7%.
  • UK employment hit a new high of 32 million in April but the pay of those in work is failing to keep up with inflation and leaving households worse off as average earnings growth excluding bonuses slipped to 1.7%.
  • Before the shock MPC vote split news, analysts had thought that the MPC on the back of low average earnings would not seriously consider a hike in interest rates any time soon and probably not before 2019.
  • UK Retail sales fell more sharply than expected in May, dropping by -1.2% month-on-month compared with analyst predictions of -0.8% with shoppers curbing spending due to rising prices and political uncertainty.
  • Moody’s has downgraded the sovereign credit rating for South Africa to Baa3 from Baa2 with a “Negative” outlook following the weakening of the South African government’s credit profile.
  • In addition Moody’s has downgraded the deposit ratings of the five largest South African banks to equalise the ratings with the downgraded sovereign credit rating for South Africa.
  • Allied Irish Banks p.l.c. is set to join the FTSE 100 as one of its biggest listings in two decades with a partial float of 25% of the shares which values the bank at about €12.0bn.
  • Moody’s has upgraded the deposit ratings of the Royal Bank of Scotland plc (RBS) and NatWest Bank plc with “Stable” outlooks as part of a rating action to reflect the stronger financial profile of the Group.
  • Despite the UK political turmoil, the FTSE European 350 Bank Index is broadly unchanged over the month, rising by 0.2% to 4,314 to reflect the general improvement in the European Union economy.
  • The ITRAXX Europe Senior Financials 5-year CDS Index again reacted positively over the month, with the price premium reducing by 10.3% to 62bps, as markets reflect general balance sheet strengthening.
Monthly Commentary:

Although the political turmoil in the UK shows little signs of abating, financial markets appear on the face of it to be relatively unconcerned about the situation for now with the ITRAXX Europe Senior Financials 5-year CDS Index improving by 10.3% to 62bps over the month while the FTSE 350 Bank Share Index of major banks has risen slightly by 0.2% to 4,314. However the share prices of UK ‘challenger’ banks have in general trended lower over the month on concerns that any significant economic weakness may have an adverse impact on credit quality and trading profits.

Moody’s has warned that the UK’s sovereign credit rating could soon be downgraded after the UK general election delivered a hung parliament. The ratings agency said the lack of a decisive majority party could put the brakes on negotiations for the UK to leave the European Union which could have a negative impact on the UK’s credit rating. Moody’s also said that the drive to reduce the UK budget deficit could be intentionally slowed down as a consequence of the election outcome raising further worries about the country’s rating.

Although the Monetary Policy Committee (MPC) voted to leave interest rates unchanged at their current record low of 0.25% there was a surprise 5-3 split among members. Market expectations were for the composition to remain at 5-1 owing to the recent political turmoil. However Saunders and McCafferty joined the soon to depart Forbes in voting for a rate hike to 0.50%. This is the first time since 2011 that three MPC members have voted to raise interest rates. This is the closest the Bank has come to raising interest rates since 2007 and appears to signal that the Bank of England (BoE) is growing impatient with the UK’s elevated levels of inflation. Some economists believe that there could be an interest rate rise delivered as early as August with the Bank looking to reverse the 0.25% cut it enacted in 2016 following the EU referendum result.

Meanwhile UK prices are rising at their fastest pace in almost four years with inflation reported above economist expectations in May. This is likely to tighten the squeeze on households and put more pressure on the BoE to respond with higher interest rates. The latest official figures from the Office for National Statistics (ONS) reported that consumer prices increased by 2.9% in May compared with the previous year as the impact of the cheap pound since the Brexit vote continues to filter through to import costs. This is the sharpest rise since June 2013 and inflation remains well above the BoE’s 2.0% target and above its recent forecast that prices would peak at 2.8% towards the end of the year. Economists had expected inflation to hold steady at 2.7%.

Other official figures from the ONS reveal that UK employment hit a new high in April while the pay of those in work is failing to keep up with inflation and leaving households worse off. While almost 32.0m people are in work, which is 372,000 more than a year ago and the highest since records began in 1971, average earnings growth excluding bonuses slipped to 1.7%. This is the weakest increase since January 2015. Unemployment fell by 50,000 in the quarter to April to 1.53m which is the lowest level for more than a decade while the unemployment rate remains at a historic low of 4.6%. However some analysts are casting doubt on the MPC’s wage growth forecast of 3.5% for next year. They further caution that should the trend in the latest figures not be reversed then the BoE’s wage forecast of 2.0% for this year could be undershot as well. With rising prices outpacing earnings growth, many analysts believe that the government might now consider removing or increasing the 1.0% cap on public sector pay rises. Before the shock MPC vote split news, analysts had thought that on the back of these figures the MPC would not seriously consider a hike in interest rates any time soon and probably not before 2019.

Further official figures from the ONS reveal that UK Retail sales fell more sharply than expected in May with shoppers curbing spending in the face of rising prices and political uncertainty. Retail sales dropped by 1.2% month-on-month which was a deeper fall than the 0.8% decline expected and appears to provide further evidence that the UK economy is faltering. Analysts pointed to increased retail prices across all sectors as a significant factor in slowing growth. Average prices excluding fuel rose by 2.8% over the year. The fall in retail sales followed a surprise 2.3% spike in the previous month which many economists had cautioned would be short lived. Sales by value rose by 1.8% which suggests that retailers are having to pass on the increased cost of imported goods to consumers.

Moody’s has downgraded the sovereign credit rating for South Africa to Baa3 from Baa2 with a “Negative” outlook following the weakening of the South African government’s credit profile. The key drivers for the downgrade were the weakening of South Africa’s institutional framework, reduced growth prospects (reflecting policy uncertainty and slower progress with structural reforms) and the continued erosion of fiscal strength (due to rising public debt and contingent liabilities).

In addition Moody’s has downgraded the deposit ratings of the five largest South African banks to equalise the ratings with that of the downgraded sovereign credit rating for South Africa. The banks affected are the Standard Bank of South Africa Limited, FirstRand Bank Limited, Absa Bank Limited, Nedbank Limited and Investec Bank Ltd. The rating agency has also downgraded Standard Bank Group Limited’s long-term issuer ratings to Ba1 from Baa3. The rating action also takes into account the reduced capacity of the South African government to provide support to banks in case of need.

Allied Irish Banks p.l.c. (AIB) is set to join the FTSE 100 as one of its biggest listings in two decades with a valuation of about €12.0bn (£10.5m). The Irish government is floating a 25% stake in London and Dublin despite the uncertainty caused by the UK election result. The initial public offering is set to be one of Europe’s largest share listings by a bank since the 2008 financial crisis. Analysts believe that it could raise up to €3.8bn if there is strong demand and the over-allotment option of a further 15% is taken up.

Moody’s has upgraded the senior debt ratings of the Royal Bank of Scotland Group (Group) and the deposit ratings of the Royal Bank of Scotland plc (RBS) and NatWest Bank plc with “Stable” outlooks to reflect the stronger standalone financial profile of the Group and on expectations for a more stable performance in the medium term resulting from the Group’s restructuring exercise. The rating action also reflects the Group’s strong capital and litigation reserves levels as well as reflecting sustainable earnings from core retail and corporate businesses which will help mitigate any downward credit pressures arising from Brexit.

See below for 5-year CDS spread and share price movements for the last month.
5-YEAR CDS SPREADS AND SHARE PRICES 
Movements over the Last Month
Date: 19th June 2017
5-Year CDS Spreads (bps) Equity Share Prices 
Financial Institutions 15-Jun-17 12-May-17 Chg 15-Jun-17 12-May-17 Chg
ABN AMRO Groep N.V. n/a n/a n/a 22.93 24.53 -6.5%
Parent: Aldermore Group plc
Aldermore Bank plc n/a n/a n/a 225 255 -11.5%
Irish Sovereign
Allied Irish Banks 42 42 -0.0% 6.00 6.14 -2.3%
Parent: Arbuthnot Banking Group plc
Arbuthnot Latham & Co. n/a n/a n/a 13.60 14.77 -7.9%
Aust and NZ Banking Group Ltd 64 55 +15.7% 28.00 29.22 -4.2%
Banco Bilbao Vizcaya Argentaria S.A. 73 80 -8.6% 7.30 7.39 -1.2%
Parent: Barclays plc
Barclays Bank plc 58 62 -7.6% 203 206 -1.3%
BNP Paribas S.A. 44 56 -22.3% 61.85 66.56 -7.1%
Parent: Close Brothers Group plc
Close Brothers Limited n/a n/a n/a 15.21 16.23 -6.3%
Credit Agricole S.A. 41 55 -25.4% 13.89 14.29 -2.8%
Parent: Credit Suisse Group AG
Credit Suisse AG 69 79 -12.6% 13.04 14.22 -8.3%
Deutsche Bank AG 93 100 -7.4% 15.12 17.19 -12.0%
Parent: HSBC Holdings plc
HSBC Bank plc 42 51 -16.8% 687 678 +1.3%
Parent: ING Groep N.V.
ING Bank N.V. 37 47 -19.9% 15.08 15.32 -1.5%
Intesa Sanpaolo S.p.A. 115 120 -4.1% 2.57 2.83 -9.3%
Parent: Investec plc
Investec Bank plc n/a n/a n/a 575 588 -2.1%
Parent: Lloyds Banking Group plc
Lloyds Bank plc 49 52 -5.9% 68 69 -1.0%
Metro Bank plc n/a n/a n/a 37.24 36.25 +2.7%
Nordea Bank AB 36 36 -0.0% 111 113 -1.6%
Parent: RBS Group plc
Royal Bank of Scotland plc 69 74 -7.4% 252 259 -2.8%
Ult. Parent: Banco Santander S.A.
Santander UK plc 68 70 -4.0% 5.89 6.03 -2.3%
Shawbrook Group plc
Shawbrook Bank Limited n/a n/a n/a 340 341 -0.2%
Societe Generale 45 56 -18.9% 46.47 49.70 -6.5%
Parent: Standard Chartered plc
Standard Chartered Bank 65 68 -3.7% 751 746 +0.8%
Svenska Handelsbanken AB 31 36 -14.3% 123 126 -3.1%
Unicredit  S.p.A. 124 136 -9.0% 15.78 17.01 -7.2%
FTSE 350 BANK INDEX n/a n/a n/a 4314 4306 +0.2%
SNR FIN ITRAX CDS 5-YEARS 62 69 -10.3% n/a n/a n/a

 

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