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Fitch Affirms Coventry Building Society at 'A'; Outlook Stable
May 8, 2017 / 1:57 PM / 5 months ago

Fitch Affirms Coventry Building Society at 'A'; Outlook Stable

(The following statement was released by the rating agency) LONDON, May 08 (Fitch) Fitch Ratings has affirmed Coventry Building Society's (CBS) Long- and Short-Term Issuer Default Ratings (IDRs) at 'A'/'F1' and Viability Rating (VR) at 'a'. The Outlook on the Long-Term IDR is Stable. Fitch has assigned a 'A(dcr)' Derivative Counterparty Rating (DCR) to CBS as part of its roll-out of DCRs in western Europe and the US. DCRs are issuer ratings and express Fitch's view of banks' relative vulnerability to default under derivative contracts with third-party, non-government counterparties. The rating actions are part of Fitch's periodic review of the UK Building Societies. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS IDRs, VR, DCR AND SENIOR DEBT RATINGS The IDRs, DCR, VR and senior debt ratings reflect the society's conservative risk appetite, driven by its focus on low-risk, low loan-to-value (LTV) prime residential and buy-to-let (BTL) mortgage loans. They also reflect the society's limited franchise and concentration of its business on the UK housing market. CBS's strategy is focussed on achieving stable and consistent profitability through a high growth, low-margin, low-cost and ultimately low impairment charges business model. The society's low risk appetite has resulted in consistently strong asset quality through the economic cycle. We do not believe the society's small portfolio of legacy commercial and specialist residential loans is a material risk to asset quality. While reserve coverage of impaired loans is low by sector standards, we believe this is offset by the low average LTV of its loan book. Consequently, write-offs have been minimal to date. CBS has maintained its profitability despite low interest rates and its undiversified income sources. We expect competitive pressures in the mortgage market to continue in 2017 which, coupled with limited scope to reduce funding costs, is likely to result in a decline in the society's net interest margin. In light of this trend, the society's continuing ability to control costs, e.g. through a limited branch network, will remain key to sustaining sound profitability. CBS's capitalisation is sound because of the low-risk nature of its loan book and sound internal capital generation. The society reported a common equity Tier one (CET1) ratio of 32.2% at end-2016, calculated on an internal ratings-based approach. The society's CET1 ratio benefits from the low risk weights of its loan book, but CBS's sound capitalisation is also demonstrated by its 4.1% regulatory leverage ratio at end-2016. Liquidity is strong. Liquidity buffers consist of cash at the Bank of England and UK government bonds. CBS also benefits from access to contingent liquidity from the Bank of England. The society is mainly deposit-funded, but it also has good access to wholesale funding, with covered bonds, senior unsecured and subordinated debt outstanding. The society has also accessed funding through the government's Funding for Lending Scheme and intends to use Term Funding Scheme. CBS's Long-Term IDR is not rated above its VR despite significant layers of subordinated debt, mostly in the form of AT1 instruments. This is because, in Fitch's opinion, the Long-Term IDR would not achieve a higher level than the current 'A' if CBS's junior debt buffer was in the form of Fitch Core Capital (FCC) rather than debt. This is primarily because of the society's business model that is concentrated on mortgage lending. We have assigned a DCR to CBS because it is a counterparty to Fitch-rated transactions. The DCR is at the same level as the Long-Term IDR because under UK legislation, derivative counterparties have no preferential status over other senior obligations in a resolution scenario. SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF) CBS's SR and SRF reflect Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities in the event the society becomes non-viable given UK legislation and regulations that provide a framework that is likely to require senior creditors to participate in losses after a failure and because of the society's low systemic importance. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES CBS's AT1 securities are rated five notches below its VR: two notches for loss severity to reflect the conversion into core capital deferred shares (CCDS) on breach of a 7% CRD IV CET1 ratio, and three notches for non-performance risk, reflecting the instruments' fully discretionary interest payments. RATING SENSITIVITIES IDRs, VR, DCRs AND SENIOR DEBT CBS's IDRs, VR and senior debt ratings are primarily sensitive to structural deterioration in profitability, through tighter margins and higher loan impairment charges, as well as weaker asset quality. This could be caused by a material weakening of the operating environment in the UK if the economic environment deteriorates substantially following the UK's decision to leave the EU. The VR and IDRs are also sensitive to an increase in the society's risk appetite, which could give rise to higher LICs, or through an increase in its cost base, either of which could lead to a material weakening in operating profitability. The society's ratings could also come under pressure if higher regulatory capital requirements, which could include a potential capital floor on BTL risk-weighting based on the revised standardized approach, put pressure on its low-risk business model. A weakening of the prospects for BTL lending could also put CBS's ratings under pressure given the society's exposure to this segment. An upgrade of the VR is unlikely because Fitch views the society's business model, which is concentrated on the UK residential mortgage lending and the savings market, as less diversified than that of its more highly rated UK peers. The Long-Term IDR could be affirmed after a downgrade of the VR if the qualifying junior debt buffer is sufficiently high to warrant an uplift at that rating level. The DCR is sensitive to changes in CBS's Long-Term IDRs. SUPPORT RATING AND SUPPORT RATING FLOOR Fitch does not expect any changes to the SR and the SRF given the low systemic importance of the building society as well as the legislation in place that is likely to require senior creditors to participate in losses for resolving CBS. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The AT1 rating is primarily sensitive to changes in the VR from which it is notched. The rating is also sensitive to a change in its notching, which could arise if Fitch changes its assessment of the probability of its non-performance relative to the risk captured in the VR. The rating is also sensitive to a change in Fitch's assessment of the instrument's loss severity, which could reflect a change in the expected treatment of liability classes during a resolution. The rating actions are as follows: Long-Term IDR: affirmed at 'A'; Outlook Stable Short-Term IDR: affirmed at 'F1' Viability Rating: affirmed at 'a' Support Rating: affirmed at '5' Support Rating Floor: affirmed at 'No Floor' Derivative Counterparty Rating: assigned at 'A(dcr)' Senior unsecured EMTN programme and notes: affirmed at 'A'/'F1' Additional Tier 1 securities: affirmed at 'BB+' Contact: Primary Analyst Joanna Drobnik, CFA Director +44 20 3530 1318 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Patrick Golling Analyst +44 20 3530 1772 Committee Chairperson Christian Scarafia Senior Director +44 20 3530 1012 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. DIRECTORS AND SHAREHOLDERS RELEVANT INTERESTS ARE AVAILABLE here. 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