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Jan 24 - In order to expand lending and improve earnings, UK banks are likely to reduce their liquidity reserves during 2013, Fitch Ratings says in a newly-published report on the UK banking sector.
The major UK banks are among those with the highest liquidity buffers in Europe. Fitch estimates that on average around 13% of the UK's funded bank balance sheets are in the form of prime liquid assets, on top of which banks hold varying buffers of secondary liquidity.
"Peak liquidity may have been reached and we are beginning to see UK banks make more active use of liquidity management, for example the buying back of debt, as well as allocating more assets to lending," said Claudia Nelson, Senior Director in Fitch's Financial Institutions group. However the reduction is unlikely to be a negative rating driver in Fitch's view as bank liquidity reserves are likely to remain high.
Fitch has Stable Outlooks on most major UK banks' Issuer Default Ratings (IDRs), reflecting the measures these banks have taken over the past three years to improve their fundamental credit risk profile (strengthening liquidity, improving asset quality and higher capitalisation) or Fitch's expectations of support should the banks get into difficulty.
Fitch's main concern is continued pressure on profitability deriving from lower revenue generation, tougher regulatory demands, stricter overview over conduct and, in some cases, continued restructuring costs/losses. Fines and customer recompense have featured largely in 2012 and are likely to continue to do so into 2013.
Low demand for credit, high capital requirements, prolonged low base rates, tougher conduct, and misselling measures, have all dampened medium-term earning prospects for the major UK banks. Fitch expects profitability targets to remain notably lower than in the past for the medium- to long-term.
Overreliance on short-term debt is no longer a rating concern. Access to the capital markets has been available recently for the UK major banks (although it remains more expensive than in the past) but like for all banks, it is subject to overall market conditions. The need of the two banks most affected by the crisis (Royal Bank of Scotland and Lloyds Banking Group ) to access thewholesale debt markets has reduced due to their de-leveraging and structurally strong liquidity. Conversely, asset encumbrance, although low, is likely to rise modestly as a result of the government's Funding for Lending Scheme.
The major UK banks are generally soundly capitalised and on target to meet Basel III requirements. However, achieving this implies continuing deleveraging and restructuring by the part-nationalised banks and possibly additional issuance of loss absorbing capital, in line with regulatory requirements. Fitch has some concerns over the very low risk weightings assigned to loans backed by real estate (residential and commercial mortgages), which are being reviewed by the UK regulator.
There is a wide divergence in asset quality. UK residential mortgage loans are performing well thanks to the high affordability allowed by low base rates. Fitch's main concerns are interest-only loans (46% of all mortgage loans) and any unexpected sharp rise in unemployment. There has been some deterioration in the performance of SME lending but overall asset quality remains sound. The main vulnerability is legacy exposure to commercial real estate (CRE), a large portion of which continues to face renegotiation, refinancing or sale while the value of the underlying assets remains under pressure, as well as the part-nationalised banks' (especially RBS) exposure to Ireland.
The longer-term trend for UK and other EU bank Support Rating Floors (SRF) is likely to be downward as resolution and bail-in agendas along with other associated practical and legal measures proceed. It is also a product of the ability of the UK ('AAA'/Negative) to support its major banks. Fitch has previously stated that, there is a degree of tolerance at the current sovereign rating level for the SRF of the UK major banks to remain at 'A' should the UK sovereign be downgraded in the future.
Link to Fitch Ratings' Report: Major UK Banks: Improved Fundamentals, Muted EarningsProspects
