DBRS Expands Its Floor Rating Concept to the United Kingdom

DBRS has today expanded its floor ratings concept for Critically Important Banking organisations (CIBs) to include the UK. Today’s announcement follows DBRS’s 11 February 2009 announcement introducing the floor rating concept, which is a refinement of DBRS’s approach to intrinsic and support assessments.

For CIBs operating in the UK, DBRS has assigned a floor rating of A (high) for long-term debt and deposits and R-1 (middle) for short-term debt and deposits at the bank level. In the cases where there is a holding company, the floor has been set at “A” and R-1 (middle). The trend on the aforementioned floor ratings is Stable. The level of the floor reflects DBRS’s expectation that the UK government will provide support, if necessary, to prevent any CIB from weakening below this rating level. DBRS views A (high)/R-1 (middle) as the level of creditworthiness that market participants demand for CIBs to be viewed as essential counterparties, as CIBs need to be perceived as reliable partners in undertaking a wide range of financial transactions. DBRS views the floor as the level of support at which the UK government will sustain their CIBs to ensure that their financial system is fully functioning.

CIBs will usually be banking organisations that have extensive involvement in a country’s financial markets and perform critical roles in the flow of financial transactions. As such, the loss of the market’s confidence in a CIB’s ability to perform as a counterparty could impact the market’s perception of other participants and lead to a degradation of the functioning of the financial markets.

In the view of DBRS, the actions taken to date by the UK government clearly demonstrate the intent to support their CIBs at this level. These actions include recapitalisation plans, schemes designed to enhance liquidity, schemes to guarantee bank credit and more recently, an asset protection scheme. In effect, the intent of these policies and the related government actions can be taken to imply that there is a floor under the potential deterioration in the final ratings of CIBs. For CIBs whose ratings are higher than the floor, the existence of the floor rating clarifies the potential for downgrades in the ratings of these institutions. Specifically, if rating pressure occurs at a CIB, which has a DBRS floor rating in place, when the floor is reached, further weakening in the bank’s intrinsic strength rating will not result in a concurrent downgrade of the final rating below the floor rating. Consequently, all ratings that are at the floor have a Stable trend.

In DBRS’s rated universe in the UK, DBRS considers HSBC Holdings plc (HSBC), Lloyds Banking Group plc (Lloyds), Barclays Bank plc, (Barclays), Royal Bank of Scotland Group plc (RBS), and Nationwide Building Society (Nationwide) as CIBs. Currently, DBRS’s ratings of HSBC, Lloyds, Barclays, RBS, and Nationwide are above the floor level and as such, their ratings are not impacted by the assignment of the floor. DBRS continues to monitor government statements and actions and may consider adding or removing banks which are considered CIBs, as warranted.

DBRS continues to ascribe implicit systemic support for certain banks in the UK as reflected in the SA2, support assessment. For institutions with a designated SA2 support assessment DBRS expects some form of external support, if needed, ideally with a timeliness element in it. The assignment of the SA2 support assessment has typically resulted in the final ratings of such institutions being positioned one notch above the bank’s intrinsic strength. Not all banks with SA2 support assessments have been designated as CIBs, as the CIB designation not only entails the expectation of some form of support, but the expectation that any CIB would receive sufficient support to maintain its credit profile at the floor rating.

Given actions taken by various governments globally, DBRS continues to evaluate the applicability of floor ratings for other banking systems in other countries. The introduction of a floor rating is likely for a country where there has been significant deterioration in one or more of the country’s CIBs that has caused disruptions to its financial markets and where substantial explicit support is being provided to its CIBs; or where the government has made explicit statements or acted so that implicit support can be inferred for its CIBs. Accordingly, where CIBs can be identified and a floor rating established, DBRS believes this provides clarity to the market on prospective rating actions for weakening institutions that are deemed to be underpinned by the floor. DBRS continues to assess other countries for application of this concept, a process that it expects to complete by the end of March 2009.

If DBRS perceives that changes in policies or specific actions indicate that a government’s willingness or ability to support these CIBs has changed, it would revisit the level established for the floor ratings or indeed the reliability of the floor itself.