Why Barclays (BCS) May Witness Ratings Downgrade By Moody's

Barclays (LON:BARC)’ (NYSE:BCS) senior unsecured debt and the Baa2 long-term issuer ratings, and the Prime-3 short-term issuer ratings have been placed under review for possible downgrade by Moody's Investors Service, a rating arm of Moody's Corporation (NYSE:MCO) .

Additionally, the baa2 standalone baseline credit assessment (BCA), the A1 long-term deposit and senior unsecured debt ratings, the Prime-1 short-term deposit ratings and the A1 (cr) long-term Counterparty Risk (CR) assessment of the bank’s operating entity Barclays Bank PLC are under review for probable downgrade. Nonetheless, Barclays Bank's Prime-1(cr) short-term CR assessment has been reiterated.

Reasons for Probable Ratings Downgrade

Andrea Usai, Senior Vice President at Moody's said, “The review for downgrade on Barclays reflects the group's ongoing credit weaknesses and likely impact of ring-fencing implementation, which have been the main drivers for the negative outlook since last September.”

Barclays is restructuring its operations given the impending requirement to separate its domestic retail and business banking operations from other business, per the U.K.'s ring-fencing rules. The company intends to fulfil this by April 2018 with Barclays Bank becoming its non-ring-fenced bank.

Therefore, Barclays’ existing U.K. retail and business banking operations will be transferred to the newly created ring-fenced bank — Barclays Bank U.K. As this new entity will become more dependent on risky wholesale and capital markets activities, it will lead to rise in risk profile and earnings volatility. Overall, these would result in “a weaker standalone credit profile for Barclays Bank.”

At present, Barclays Bank’s ratings are supported by Barclays’ strong businesses, solid loan growth and diversified funding sources, partially offset by weaker net profitability (expected to continue over the next few quarters) and capital markets activities.

What Will Moody’s Review?

As part of review, Moody’s intends to reassess the standalone credit profiles of Barclays Bank (following the rind-fencing) and broader Barclays. This will include whether business diversification going forward will support stable profits “sufficient to maintain the one-notch positive adjustment for Business Diversification, currently included in the BCA for Barclays Bank.”

Moody’s also plans to assess the expected loss for each instrument class issued by Barclays, Barclays Bank and Barclays Bank U.K. through its advanced Loss Given Failure analysis. Further as a result of implementation of ring-fencing, Moody’s for the first time will provide “separate notional BCA to the broader Barclays group.”

Our Take

Barclays’ restructuring and business simplifying efforts have ended successfully and will likely continue to result in decrease in expenses. Also, driven by these efforts, the company intends to announce dividend of 6.5 pence per share (subject to regulatory approvals) in 2018.

While Moody’s review (expected to be completed over next few weeks) may weigh on the stock in the near term, improving global economy will support Barclays’ profitability.

Over the last six months, this Zacks Rank #3 (Hold) stock has rallied 17.9% on the on the NYSE, outperforming the industry’s growth of 10%.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here

Notably, other than Barclays, the rating agency have put some other finance companies including E*TRADE Financial Corporation (NASDAQ:ETFC) and U.S. Bancorp (NYSE:USB) under review.

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