Moody's Negative Outlook On U.K. Banking System Post-Brexit

U.K.’s vote to exit the European Union (EU) in a referendum on Jun 23 came as a bolt from the blue for financial markets across the globe. The after effects came in the form of resignation of the British Prime Minister David Cameron and forecast of a mild recession by early 2017 in the U.K. by the Wall Street bigwig The Goldman Sachs Group, Inc. (NYSE:GS) .

The latest Brexit aftershock turned out to be outlook changes by Moody's Investors Service, the rating services arm of Moody's Corporation (NYSE:MCO) . Moody's changed the outlook on the ratings of 12 U.K. banks and building societies, while the outlook on the U.K. banking system was changed to negative from stable in the wake of Brexit concerns.

The economic and political uncertainty has escalated as a result of Brexit. Also, Moody's recent change in the outlook of the U.K.'s Aa1 government bond rating to negative from stable triggered the current rating actions, which reflect Moody's apprehension that U.K.’s decision to leave the EU will reduce the profitability of these 12 U.K. banks and building societies.

Outlook Changes

The outlook on the ratings of eight banks and building societies including Barclays (LON:BARC) PLC (NYSE:BCS) , HSBC Bank plc [the main banking subsidiary of HSBC Holdings (LON:HSBA) plc (NYSE:HSBC) ], Santander (MC:SAN) UK PLC, Coventry Building Society, Leeds Building Society, Nationwide Building Society, Nottingham Building Society and TSB Bank were changed from stable to negative.

Moreover, the outlook on the ratings of two issuers including Lloyds Bank, the main banking subsidiary of Lloyds Banking Group (LON:LLOY) plc (NYSE:LYG) , and Principality Building Society were changed from positive to stable. Also, the outlook on the U.K. government guaranteed senior unsecured debt instruments of issuers like Lloyds and Barclays, as well as Bradford & Bingley and NRAM was changed to negative from stable.

On the other hand, the outlook for four U.K. banks and building societies including The Royal Bank of Scotland (LON:RBS) Group plc (TO:RBS) , Skipton Building Society, West Bromwich Building Society and Yorkshire Building Society were maintained.

Notably, the ratings of all the above-mentioned firms were affirmed by Moody's.

Reasons

According to Moody's, heightened uncertainty over U.K.'s future trade relationship with the EU will lead to lower economic growth over the next two years, lower credit demand, higher credit losses and more volatile wholesale funding conditions for its financial institutions.

Moody's expects real GDP growth to be around 0.5% lower in 2016 and roughly 1% lower in 2017 than the agency's previous forecasts of 1.8% and 2.1%, respectively, due to ebbing confidence and reduced spending and investment.

Moreover, the U.K. will need to renegotiate new "passporting" agreements with its EU partners, which could result in additional costs for banks, if the final agreements fail to replicate current conditions.

The impending destabilization in operating environment as a result of Brexit led Moody's outlook downgrades for the U.K. banks and building societies.

However, despite the abovementioned concerns owing to Brexit, the rating affirmations reflect the creditworthiness of these institutions.

Our Take

Analysts expect economic growth to be hit, bad loans to go up, funding costs to rise and investment banking revenues to fall following Brexit, putting British banks at a huge risk. This justifies Moody’s current rating actions.

The long-term ratings of the holding companies like HSBC and Lloyds will be under pressure in case its main operating units face further downward ratings revisions.

Nonetheless, the ratings affirmation despite several adverse issues proves to be a silver lining for the U.K. financial institutions.