UK Credit Rating: Why it’s been cut and why it matters to you

It’s been a torrid few days since the UK voted to leave the European Union and today has not been any better with the news that the FTSE 350 (FTSE 100 and FTSE 250 combined) has lost £140 billion in value and Standard and Poor’s Global Ratings (S&P) has cut the UK’s pristine AAA credit rating not by one level, but two and changed their outlook to negative, which signals a potential for additional downgrades down the road.

Fitch have also now downgraded the UK’s rating from AA+ to AA and also changed their outlook from stable to negative. This combined with the news that the FTSE 350 (FTSE 100 and FTSE 250 combined) has lost £140 billion.

In this post I’m going to take a look at who the rating agencies are, what they do, why they matter, what the downgrade and outlook mean, their effect and why you should care.

Who are the ratings agencies?

There seven notable ratings Standard & Poor’s, Fitch, Moody’s, DBRS, China Chengxin Credit Rating Group, Dagong and JCR. Of these the three major ones, Standard & Poor’s, Moody’s and Fitch have approximately 95% market share between them (with Moody’s and Standard & Poor’s having approximately 40% each, and Fitch around 15%) these are the ones I’m going to focus on.

Standard and Poor’s Global Ratings (S&P)

S&P Global Ratings is one of the big three and its predecessor organizations have been in business for more than 150 years. They are one of the world’s leading providers of independent credit risk research across industries and benchmarks, asset classes and geographies. Their main reason for existing  goal is to help their clients, investors and other market participants make more informed business and investment decisions. According to their website they currently have ratings in place on $47.5 Trillion in debt.

Moody’s Investors Service (Moody’s)

Moody’s are the only standalone company of the big three, the other two being part of larger groups, and have been in existence since 1909 when they were founded by John Moody to produce manuals of statistics about stocks and bonds as well as providing ratings. Moody’s rate securities differently to S&P and Fitch Ratings, who measure the probability that a security will default, while Moody’s ratings seek to measure the expected losses in the event of a default.

Fitch Ratings

Fitch Ratings are part of the Fitch Group are the smallest of the big three ratings agency’s who often promote themselves as the tie breaker for investors when the two larger agencies have a differing view.

What do ratings agencies actually do?

The ratings agency’s provide a valuable service to investors and banks by providing universal ratings based on significant amounts of analysis and research across different types of investments but the important issue for the UK is that they all rate government issued bonds, the way governments borrow money,  so they understand the risks involved in the lending and make appropriate decisions on whether to purchase bonds and the rate of interest they should expect.

Why do the ratings agencies ratings matter?

As with personal credit ratings and lending, the higher the perceived risk of default the higher the cost of borrowing and the more challenging it is to borrow money.

What has actually happened to the UK’s ratings?

The UK’s ratings have fallen across the board since the UK’s vote to leave the European Union, I’ve included the before and after rating from each agency below.

2342341Standard and Poor’s

On Monday, Standard & Poor’s Global Ratings changed it’s rating from AAA (Triple-A) credit rating, a perfect score, to AA two levels lower. They also switched their outlook from Stable to Negative which means that S&P think that further downgrades are likely.

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Fitch

Fitch Ratings has downgraded the Bank of England’s (BoE) Long-Term Issuer Default Rating (IDR) to ‘AA’ from ‘AA+’ following the downgrade of the UK sovereign rating. The Outlook is Negative. The BoE’s senior unsecured Long-Term rating has also been downgraded to ‘AA’ from ‘AA+’. Again this means that Fitch believe there is a risk of further downgrades being necessary.

 

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Moody’s

Moody’s current rating is Aa1 (one down from perfect) and has been since 23 February 2013, however they have changed the outlook from Stable to Negative.

Why did this happen?

If you get time it’s worth actually reading the press releases from Moody’s, Fitch and S&P because they actually explain in detail their thinking behind changing the ratings but in short they all agree that the referendum result “will herald a prolonged period of uncertainty for the UK” and that the predictability and effectiveness of the governments policy making is in doubt. The ratings agency’s all believe that this will combine to make the UK’s financial strength lower, which considering the agencies ratings are used as the basis for the interest the UK pays on it’s bond, could be at least in part a self fulfilling prophecy.

Moody’s weren’t shy about attributing the reason for this “Moody’s does not believe that the negative effects from lower growth will be fully compensated by the fiscal savings from the UK no longer having to contribute to the EU budget.”

This shouldn’t be a surprise to anyone listening to economic experts for the last few months, independent analysts have almost unanimously warned this would happen as the actual cost of membership compared to the economic benefit the UK receives and the impact of the uncertainty leaving without trade deals causes for businesses.

What impact does this have?

In general, a credit rating is used by sovereign wealth funds, pension funds and other investors to gauge the credit worthiness of the United Kingdom so this has a big impact on the country’s borrowing costs. This is particularly important for the UK as it has a large national debt to service which stood at £1,600.2 billion and to date the UK government has done it’s best to maintain high, and stable, ratings which has allowed them to reduce the impact of government cuts, that the UK population already feel have hit hard.

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The British Government’s debt is owned by a wide variety of investors, most notably pension funds. These funds are on deposit, mainly in the form of Treasury bonds at the Bank of England. The pension funds, therefore, have an asset which has to be offset by a liability, or a debt, of the government. As of 2011 around 35% of the national debt was owed to overseas governments and investors.

Conclusion

Despite many who were prominent in the Leave campaign using George Osborne’s post referendum speech where he confirmed he would not immediately push through what Leave had described as a ‘Punishment Budget’ the reality is that the decision has just been kicked down the road and will still need to happen.

The reason for this is that the UK’s borrowing costs are likely to increase now and although the deficit has been cut significantly over the last few years the UK government still runs the economy at a loss and we have large public debt.

This is why George Osborne has spent much of his morning today speaking to various news agencies explaining that the spending cuts and tax rises will still need to take place, this isn’t ‘Project Fear’ it’s the reality of the choice that the UK has made.

There isn’t much we as individuals can do to change the reasons the tax rises and/or additional cuts that will need to happen to continue to service our debts directly.

That being said it’s incredibly important to continue to spend money with UK company’s, especially small businesses, and purchasing UK goods and services as this supports the overall economy will help improve the economic picture that these ratings and in turn our interest rates are based on.

So please don’t panic, stay informed, know what to expect and live your lives and be prepared for the changes that are coming, these are not going to be easy whoever implements them and they are going to be economically and not politically driven.

What do you think?

I hope you’ve enjoyed this article, or at least found it useful.

As always I’d love to hear your thoughts, if you have a different view or even if you just have more questions.It’s only by working together and staying informed we’ll get through this.

Sources and Further Reading

BBC

Economics Help

Fitch

Forbes

Moody’s

S&P

Wikipedia

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