Negative impact on creditworthiness will increase in proportion to severity and duration of crisis, says rating agency.
Moody’s Investors Service downgraded the long-term deposit ratings of three UK banks – Lloyds, Santander UK and HSBC – from A1 from Aa3 and changed the outlooks on the banks’ ratings to stable from negative on October 20.
The move follows the rating agency’s downgrade of the UK’s sovereign debt rating to Aa3 with a stable outlook, from Aa2 with a negative outlook on October 16.
“The pandemic has triggered an economic shock of uncertain scale and duration that will negatively affect the creditworthiness of UK domestic banks,” Moody’s stated in an accompanying report.
However, the rating agency estimated that UK banks’ profitability will partially recover from the second half of 2020, although asset quality will deteriorate from current levels.
Moody’s said that while the pandemic and Brexit carry downside risk, it expected bank profitability to recover from 2021, and anticipated that problem loans will peak below the level of the last cycle.
Moody’s warned the overall credit impact would be greater if bank capital were to materially deteriorate, with little prospect of a return to pre-crisis levels within two to three years. “The banks’ capitalisation will remain robust, suggesting that they are well-placed to weather the shock. However, the negative impact on their creditworthiness will increase in proportion to the severity and duration of the crisis,” Moody’s said.
The impact of Brexit on the banks’ ratings is described as moderate in Moody’s base case and ‘no deal’ scenarios. The UK and EU aim are currently in negotiations to agree a new economic relationship by December 31, 2020, when the current post-Brexit transition arrangements expire. Moody’s base case is that the two sides will reach a loose agreement limited to free trade on goods by the deadline.
“A no-deal Brexit would lead to a further moderate increase in problem loans and lower core returns. However, the credit impact would likely be limited, as the adverse effect of the pandemic on asset quality and profitability would still surpass any Brexit-related deterioration,” the rating agency said.