OREANDA-NEWS. No further near-term rating actions are expected for UK structured finance (SF) transactions following the UK vote to leave the EU, says Fitch Ratings. No change has been made to sector rating outlooks given the likelihood that asset performance will suffer little immediate impact. However, depending on the terms of the exit, mortgages and leveraged loans could experience longer-term underperformance. Consumer ABS, such as credit card and auto loan transactions, enjoy rapid repayment rates and are therefore less vulnerable to rating actions, even over the mid to long term.

The elevation in risk premiums following the UK vote to leave the EU will weaken private sector financial conditions in the UK, although the effect on SF ratings will depend on the nature of the political settlement brokered, which is likely to unfold over several years. The longer there is significant uncertainty, the greater the likelihood of a hard landing for UK SF markets. Unless a favourable exit can be secured, the referendum result raises the prospect of materially greater tail risk across SF, principally focused on the UK.

Within UK RMBS, buy-to-let (BTL) and legacy nonconforming deals are more at risk. For BTL, a reduction in immigration would temper upward pressure on rents, and in some markets lead to nominal declines as well as longer voids (currently at all-time lows). With little offset in debt service affordability available to borrowers from lower interest rates, this is likely to lead to higher arrears. For legacy nonconforming deals, we also expect higher delinquencies if economic growth falters.

Credit card performance would suffer in this scenario, although a substantial deterioration from today's levels is already built into Fitch's assumptions. Lenders also have a wide array of risk-mitigation techniques at their disposal. The credit performance of other consumer finance products such as personal loans and auto-loans would also weaken, although the pace of ABS note deleveraging (given short average lives) mitigates the effect on seasoned deals.

Exposure to second-hand UK car prices has grown in recent years and is now moderate, which introduces a less predictable risk driver: weaker sterling should buoy new car prices and may support used car prices through substitution effects, whereas lower household incomes should depress prices across the board. Fitch expects these opposing forces will broadly cancel each other out.

European high yield corporate credit quality will weaken, with 'B' category credits in pro-cyclical discretionary consumer and fixed-asset related sectors in the UK most affected. European CLO exposure to UK high yield credits (and related FX risk) is limited. More defaults of high yield UK retailers could exacerbate downward pressure facing UK retail property. CMBS exposure to this sector is dominated by prime super-regional shopping centres, and as current yields are well below Fitch's base case, values would have to fall significantly to trigger downgrades.

Another commercial property sector exposed to the referendum result is London office, which faces both reduced investment demand (given reliance on foreign capital) and concerns over the potential relocation of financial services. Market conditions are weakening already, and Fitch expects this to mark the end of the current cyclical upswing in London office investment conditions that raised values well above sustainable levels.

One CMBS, Ulysses (European Loan Conduit No. 27) PLC, was downgraded yesterday partly on fears the vote will tighten short term refinancing conditions for London offices. However, most CMBS exposure to London offices is insulated from the immediate impact on market confidence. Broadgate Financing plc has been affirmed since the vote and Canary Wharf is similarly anchored by long leases to high credit quality tenants, which underpins considerable amortisation. Land Securities Capital Markets plc operates with low leverage and has significant access to liquidity.

Revisions to UK economic expectations, particularly those relating to unemployment and interest rates, may affect SF ratings given these factors are key drivers of credit performance. While our base case is for them to remain in check, an unfavourable exit that hits UK trade (particularly in financial services) harder than our central expectation could see both unemployment and interest rates rising over the medium term as firms and households struggle to adjust to lower growth and a weaker pound. A spike in defaults would act as a trigger for house prices to fall from their currently unsustainable levels in relation to income. Fitch estimates a 25% correction would restore longer term sustainability.

In this scenario, which is at the negative end of the envisioned spectrum, UK RMBS, SME and consumer ABS transactions without sufficient build-up of additional credit enhancement would face negative rating action as household balance sheets became impaired, rebounding stress back to the UK financial sector and sovereign. Despite the prospect of falls in prime UK office and retail property prices of over 30% in such a scenario, CMBS would be relatively unaffected given the legacy UK book has largely been worked out. However, European CMBS and CLOs would both suffer as UK risk spills over into European financial markets, triggering a spike in defaults as European loans fail to refinance.