UK sovereign rating downgraded by Fitch, raising questions for HA credit prospects

News28 Mar 2020Luke Cross

Fitch has downgraded the UK sovereign rating to AA-, citing a significant weakening of the UK’s public finances and a “fiscal loosening stance” caused by the impact of the COVID-19 outbreak.

Fitch has cut the UK sovereign rating (picture: Getty)

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UK sovereign rating downgraded by Fitch in response to the COVID-19 crisis, raising questions about what could be in store for housing association credit prospects #ukhousing #coronavirus #socialhousingfinance

Describing the “unprecedented shock on financial markets and economic activity”, Fitch said the one-notch revision from AA follows a “necessary response” by chancellor Rishi Sunak, which will mean a sharp rise in general government deficit and debt ratios, leading to an acceleration in the deterioration of public finance metrics over the medium term.

It said there is some uncertainty around the fiscal impact, which will depend on the severity and length of the lockdown and the sustainability of any progress in coronavirus containment.

The strength of the recovery is also “subject to lingering Brexit uncertainty, as the final shape of any future trade deal with the EU remains unknown and the risk of the transition period ending without a deal persists”.

The decision raises the question of whether other ratings agencies – Moody’s, which rates the UK at Aa2 negative, and Standard & Poor’s (S&P), which rates it at AA stable – may also move on the sovereign rating.

Fitch, like Moody’s, already had the UK on a negative outlook, while S&P moved the UK from a negative outlook to AA stable in December last year.

Such a decision could be of detriment to UK housing associations, whose credit ratings generally receive an uplift from the likelihood of ‘extraordinary’ support from the UK government in the event of a financial failure.

Along with their link to the UK sovereign rating, housing association operating margins and financial metrics may come under pressure through a combination of a hiatus in development and increased rent arrears.

Just this week, welfare and pensions secretary Thérèse Coffey said that Universal Credit claims rocketed to almost half a million in the space of nine days.

The Regulator of Social Housing, however, told Social Housing this week that English housing associations have the liquidity and financial tools they need to weather the impact of higher arrears amid the coronavirus pandemic.

Fitch is less active in the sector than Moody’s and S&P, and has ratings for around half a dozen HAs, including Notting Hill Genesis, Hyde, A2Dominion and Great Places.

In November, Moody’s affirmed the credit ratings and outlooks for 39 housing associations, despite revising down the outlook for the UK sovereign to negative, noting the impact of increased capital grant through strategic partnerships and a “credit-positive” social rent policy.

In 2017, it downgraded 40 associations and five councils after its UK rating cut due to the planned exit from the European Union and continued pressure on public finances, particularly in relation to the welfare bill.

S&P’s downgrade of the UK sovereign in 2016 – also in relation to the Brexit vote – affected 22 housing associations.

S&P said in October 2019 that a potential ‘no-deal’ Brexit could trigger downgrades for half of its 40 rated housing associations, given the projected economic contraction, with a substantial drop in house prices and downward pressure on the sovereign rating.

However, it added that the ultimate impact would depend on the response of housing association leadership teams, highlighting that associations “have mitigation strategies in place that they can swiftly implement”.

UK sovereign downgrade impacts

In a report to clients on the COVID-19 crisis recently, advisory firm Centrus said it is “highly likely that the UK (along with other affected countries) will suffer ratings downgrades”.

For Fitch, it said if the sovereign was downgraded to the same rating as any individual housing association, the association would no longer receive an uplift, and if an association remains within the agency’s scoreband, it would continue to receive a one-notch uplift but at “best” would get up to one notch below the government level.

For S&P, it said a change in UK sovereign’s outlook again to negative watch would imply a consequent change in outlook for a number of housing associations, and a downgrade “is likely to have the impact of downgrading a number of HA credits”.

On Moody’s, the Centrus report said that despite a moderate response in November, “clearly the situation has changed”, and given the degree of the current economic shock the agency’s view “may become less sanguine over time, potentially leading to downgrades in housing association ratings”.

Centrus added: “It is also clear of course that the underlying ratings, prior to the application of implied government support where relevant, are vulnerable to deterioration in the current circumstances.

“That is due to a combination of projected credit metrics such as operating margins and debt ratios, as well as potential impacts on the underlying business risk profile if the ability of tenants to pay is materially impacted for an extended period of time.”

Why Fitch downgraded the UK sovereign

In a statement last night (27 March 2020), Fitch said: “The downgrade reflects a significant weakening of the UK’s public finances caused by the impact of the COVID-19 outbreak and a fiscal loosening stance that was instigated before the scale of the crisis became apparent.”

Fitch added that the downgrade also reflects the deep near-term damage to the UK economy caused by the coronavirus outbreak and the lingering uncertainty regarding the post-Brexit UK-EU trade relationship.

The UK’s public finances were already set to weaken following the stimulus measures announced in the Budget on 11 March, and they are now set to deteriorate more rapidly, according to the agency.

However, it added that the “swift and co-ordinated macroeconomic policy response” by the UK Treasury and the Bank of England (BoE) should limit the second-round effects of the initial shock and should help in a return to economic growth, assuming that the immediate health crisis subsides.

The agency welcomed BoE actions such as cutting the base rate and restarting quantitative easing, which will include buying gilts and corporate sector bonds.

As reported by Social Housing this week, some housing associations have been calling to be included in this bond-buying scheme, with the hope that the programme will lower their cost of funds.

Providing its economic outlook, Fitch said that UK GDP could fall by close to four per cent in 2020, assuming containment measures can be unwound in the second half of the year, allowing the economy to respond and triggering a sharp recovery in growth to around three per cent in 2021.

It said the COVID-19 response fiscal package will cost 4.4 per cent of GDP, including 1.3 per cent as a result of the Coronavirus Job Retention Scheme, assuming that 4.7 million employees will be supported over the three-month duration of the scheme.

However, a second wave of infections and a longer lockdown period would see an even larger decline in output in 2020 and a weaker recovery in 2021.