Fitch Ratings views the announcement by H.M. Treasury (UK government) of a broad support package as a positive development for the UK banking sector, which it estimates will provide a significant lift to participating banks' aggregate Tier 1 capital. Fitch also notes that despite the heavy upfront fiscal cost of the measures taken by the UK government today, the UK's strong credit standing is able to withstand considerable fiscal deterioration without threatening its 'AAA' rating.
"We estimate the effect of increasing the aggregate Tier 1 capital for the eight banks listed in the government's announcement would be a significant 17%, adding an estimated 130bp to the aggregate weighted Tier 1 ratios for those banks," says Gordon Scott, Managing Director in Fitch's Banks team. Fitch believes the availability of a government guarantee on new debt issuance - which Fitch expects to rate 'AAA' subject to review of the terms of the guarantees - will provide much needed access to medium-term funding, and the extension and broadening of liquidity facilities by the Bank of England will provide an additional measure of relief. The package announced today addresses three distinct areas - capital, funding and liquidity: The UK government will make Tier 1 capital (expected to be in the form of preference shares or permanent interest bearing shares (PIBS) available to UK incorporated banks and building societies that have "a substantial business in the UK". Applications will be considered from other UK incorporated banks and building societies but their role in the UK banking system and broader economy will be key factors in any decision. The eight largest UK incorporated institutions (Abbey, Barclays, HBOS, HSBC Bank, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland, and Standard Chartered) have confirmed their participation in the scheme, reflecting their commitment to increase their aggregate Tier 1 capital by GBP25bn. Aggregate Tier 1 capital for the eight named banks at end-2007 was GBP148bn, which means that the initial incremental capital will increase the weighted average Tier 1 ratio to 9.3% from 7.9%. An additional minimum amount of GBP25bn will be made available in the same format should it be required. Fitch's calculation of capital is based on its eligible capital ratio, which caps recognition of hybrid capital instruments at 30% of Tier 1 capital. Some of the banks listed are at or close to this threshold, but Fitch will exclude government-subscribed preference shares or PIBS from this restriction. At this point in time it is not clear whether the government-subscribed preference shares will rank pari-passu to or senior to similar existing instruments. The government's announcement suggests UK banks will be given higher Tier 1 target ratios than currently exist but no clarity has been provided on this as yet. Fitch will make appropriate comments on a bank-specific basis when more information becomes available. Government capital injections will carry appropriate terms and conditions which could include restrictions on dividend payments and executive compensation as well as a commitment to support lending to areas of the UK economy that have been particularly badly hit by the credit crunch, namely small businesses and the housing sector. For those banks and building societies that the government considers are appropriately capitalised (after taking into account of higher implied capital targets), a government guarantee of new short- and medium-term debt will be made available on "appropriate commercial terms". It is expected that new senior unsecured debt of terms up to three years will be covered by this arrangement. Subject to a satisfactory assessment of the guarantee arrangements and conditions applicable, Fitch would expect to rate qualifying debt at 'AAA' (the UK sovereign rating). Current government estimates for the take-up of the guarantee will be around GBP250bn. Fitch views this development as particularly positive since the rapidly diminishing availability of longer-term funding has proved to be one of the catalysts for the credit crunch and reduced availability of financing for home buyers. By their nature, banks are vulnerable to market confidence, and funding positions for most international banks have come under some pressure as longer-term markets have remained difficult and, in recent weeks, short-term markets have seized up. Nevertheless the major UK banks have continued to fund themselves albeit maturities, like in most banks, have become more concentrated in short-term, thereby increasing potential vulnerability to market shocks. Today's announcement that the Bank of England will continue to provide liquidity to the UK banking system, extending and broadening its short-term facilities and increasing the availability of collateralised funding through the Special Liquidity Scheme to at least GBP200bn is expected to provide some relief from these pressures. The Bank of England is also expected to announce next week the introduction of a permanent discount window regime aimed at providing a permanent liquidity facility for the banking system. The major UK banks retain significant strengths, including broadly diversified revenue streams, and a high proportion of retail funding. Nevertheless, a number of businesses such as wholesale and investment banking are expected to demonstrate increasing earnings volatility, and those banks more heavily exposed to weakening economies and housing markets will face heightened cyclical pressures. Fitch expects earnings and asset quality to be weaker in 2009. Potential remains for additional write-downs on credit market exposures, and a strengthening of capital positions is viewed positively. Fitch expects ratios to be managed at more conservative levels than in the past. Fitch estimates the gross fiscal cost of measures by the UK government to date in response to the financial crisis is GBP100bn (USD175bn), equivalent to 7% of GDP, a similar magnitude relative to national income as the USD1trn (GBP570bn) of measures announced by the US government over recent weeks and months. The net fiscal cost to the UK government will be substantially less, however, as it is acquiring assets, albeit of an uncertain value, which will generate income that will at least partially offset the gross cost. The UK Treasury's confirmation that half of the GBP26bn lent to Northern Rock (included in the gross estimate) has now been repaid underscores the net fiscal cost will be lower than the headline figures suggest. Nevertheless, the potential fiscal cost of the increase in the insured limit for UK deposits from GBP35,000 to GBP50,000 is uncertain (though the estimated GBP5bn cost of compensating UK depositors with Icesave - which has fallen solely on the UK government following the failure of the Icelandic deposit insurance scheme - highlights the fiscal risks with such a guarantee), as is the fiscal cost of the GBP250bn bank debt guarantee programme announced today. Fitch treats the financial guarantees by governments (such as the Irish government guarantee of all bank deposits and debts) as a contingent liability that does not have any immediate fiscal or budgetary cost, though the governments' exposure to risk has increased sharply as a result. Nevertheless, the financial commitments by the UK authorities are denominated in sterling and the government has sufficient fiscal flexibility and policy credibility such that its access to funding and ability to borrow is unfettered. "The UK's credit standing remains of the highest standard. There is sufficient headroom within the tolerance of the UK 'AAA' rating to absorb a sizeable near- term fiscal deterioration arising from measures to stabilise the financial system and prevent an excessively deep and prolonged recession," says David Riley, Head of Sovereign Ratings at Fitch. The framework by which Fitch assesses the fiscal and sovereign credit implications of the various measures taken by governments around the world in response to the current financial crisis are outlined in a Special Report that will be published later today, 'Sovereign Credit Implications of Financial Sector Support', and freely available from its website, www.fitchratings.com
--www.theasianbanker.com (October 13 2008)--
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