Welcome to our October edition of ‘Insight’ by Insignis. Each month, we discuss a topic of interest within the UK financial sector.
In many ways, 2020 was a tough year for banks. The COVID-19 pandemic generated instability and high volatility across the financial sector. Recoveries were expected to be slow, uncertain, and varied across regions.
The economic state was so dire that rating agencies reverted to widespread negative rating actions. Credit rating company S&P Global went as far as to state that 2021 had the potential to be the “toughest test for banks” since the aftermath of the global financial crisis in 2009.
However, despite the gloomy outlook predictions, Q1 and Q2 of 2021 have seen the reversal of many of the negative banking credit rating actions.
In this article, we’ll delve into how a dim credit outlook in 2020 has quickly been replaced with promise in 2021 and what this means for your clients’ deposit risk.
In response to the uncertain conditions caused by the pandemic, the big 3 rating agencies; S&P Global, Moody’s and Fitch Ratings, reverted to widespread negative rating actions on much of the global banking sector.
In its simplest form, a credit rating is a formal, independent opinion on the relative ability of a bank to meet its financial commitments, whereas a rating outlook indicates the potential direction for change in a bank’s formal rating.
The rating actions which were undertaken in 2020 were largely downgrades of formal ratings or changes to negative outlooks.
From the onset of the pandemic to the 9th of November 2020, S&P Global executed 236 negative rating actions on banks globally. The majority of the actions formed revisions of positive/stable outlooks to negative outlooks (or placements on CreditWatch negative) at 77%, with the remaining 23% of actions forming formal rating downgrades.
This pointed towards an extremely uphill credit battle in 2021.
Outlooks and ratings largely remained the same for Q4 of 2020/21. However, by Q1 2021/22, a significant proportion of outlooks were revised from ‘negative’ to ‘stable’ as the pressure from the pandemic began receding.
Fitch declared that of their 264 formal bank rating actions between the 1st of April 2021 to the 30th June 2021, 82 outlooks were revised to ‘stable’, 6 to ‘positive’ and only 3 were revised to ‘negative’. 14 formal ratings were upgraded in that period and no rating outlook was revised downward.
In the UK, institutions such as Lloyds Banking Group, Santander UK, Virgin Money, Nationwide Building Society and Investec, all saw their UK operations receive outlook revisions from ‘negative’ to ‘stable’ in the first few months of the new financial year.
A more positive outlook continued in Q2. During this quarter, Fitch saw the proportion of their bank ratings on ‘negative’ outlook (or negative watch) creep below 50% for the first time since the end of 2019, and the initial outbreak of the crisis. By the end of the quarter, this figure had lowered to 40%. The reduction in negative outlooks signified increased positivity surrounding the strength of the banking sector and their ability to meet their financial commitments.
Although several outlooks were revised in 2020, formal credit rating downgrades remained rare, reflecting the fact that banks were in a much stronger position to withstand and bounce back from financial turbulence when compared to the 2009 financial crisis.
Stricter supervision from regulators and improved internal procedures led to increased capitalisation and reduced leverage, providing foundations for most banks to remain strong during the pandemic and quickly benefit from economic recoveries. The improved resilience has been tested by the pandemic and was recognised by the rating agencies in their rating actions.
However, the primary force for the upward outlook revisions derived from improvements in the operating environment. Vaccine rollouts, among other factors, led to improved expectations for economic recovery according to the assessments of the rating agencies. In the UK, Fitch revised the overall operating environment score for UK banks with predominately domestic operations from ‘negative’ to ‘stable’.
Credit Ratings define a rating agencies opinion on the relative ability of an entity to meet financial commitments and therefore, form an important consideration concerning counterparty default risk when choosing where to place client funds.
Insignis enables you to access over 40+ banks and building societies, several of which hold formal investment-grade ratings, from one single sign up. We can also provide you with access to credit rating data concerning our partner banks and building societies and can work with counterparty and investment policies, whilst maximising interest return.