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Fitch Revises Santander UK Group's Outlook to Stable; Affirms at 'A'
February 7, 2017 / 4:57 PM / 6 months ago

Fitch Revises Santander UK Group's Outlook to Stable; Affirms at 'A'

(The following statement was released by the rating agency) LONDON, February 07 (Fitch) Fitch Ratings has revised the Outlook on Santander UK Group Holdings plc's (SGH; the holdco), Santander UK's (San UK; the main operating bank) and Abbey National Treasury Services plc's (ANTS) Long-Term Issuer Default Ratings (IDRs) to Stable from Positive and affirmed the IDRs at 'A'. The Short-Term IDRs have been affirmed at 'F1'. A full list of rating actions is at the end of this rating action commentary. The revision of the Outlooks to Stable reflects Fitch's view that the weaker prospects for the banking sector after the UK's decision to leave the European Union will make it more difficult for SGH's earnings to benefit from a diversified business mix. We expect the UK banking sector profitability to be affected by low interest rates, which coupled with a slowdown in domestic lending demand, will put pressure on earnings. In our opinion, this is likely to constrain the group's ability to expand its retail, commercial and corporate franchises. In addition, the group's decision to adopt a wider ring fence model will further restrict its ability to diversify. Fitch has assigned a 'A(dcr)' Derivative Counterparty Rating (DCR) to San UK and ANTS as part of its roll-out of DCRs to significant derivative counterparties 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 major UK banks. KEY RATING DRIVERS IDRS, VRs, DERIVATIVE COUNTERPARTY AND SENIOR DEBT San UK's IDRs, DCR and senior debt ratings are driven by its VR, which reflects the group's conservative risk appetite, healthy asset quality, strong funding and liquidity profile, adequate capitalisation and the benefits of being an important part of the Santander Group (Banco Santander SA; A-/Stable). The VR also reflects the group's less diversified business model, which concentrates on the UK, and higher than average leverage. SGH's VR and IDRs are equalised with San UK's to reflect SGH's role as a holding company for the UK-based subsidiaries and the lack of holding company double leverage at SGH. Asset quality is strong and stable and compares well with peers. SGH's gross non-performing loans, defined as impaired loans plus all loans which are 90 days past due but not impaired, represented a healthy 1.5% of gross loans at end-2016. In our opinion, this reflects the group's prudent risk appetite. The bank's mortgage portfolio, which represents around three-quarters of the overall loan book and is largely focused on low-risk, low loan-to-value (LTV) owner-occupied mortgages, is of high quality. Furthermore, the bank's exposure to higher-risk businesses, such as specialist mortgages and buy-to-let is low relative to similarly rated peers. SGH has some appetite for commercial real estate lending, which represented a high three-quarters of Fitch Core Capital at end-2016. These loans are performing soundly while new lending is well collateralised. This should provide the bank with a significant cushion in case of asset-value declines. The bank has taken advantage of a period of benign economic conditions in the UK and rising investor appetite to dispose of non-core assets and increase the reserve coverage of remaining legacy impaired loans. At end-2016, the bank's remaining non-core portfolio was GBP6.5bn (end-2015: GBP7.4bn), about 3% of customer loans, and Fitch does not expect material additional losses from this portfolio. The majority of non-core loans relate to low-risk social housing lending. The remaining non-core loans, which include the bank's aviation, shipping and commercial mortgage portfolios, are generally well covered by collateral or are well provisioned. SGH's profitability is comparable with similarly rated peers despite the larger proportion of low-yielding, low-LTV prime residential mortgages and relative low loan growth. Profitability is sound, supported by strict cost control, low loan impairment charges (LICs) and the absence of material conduct costs. We expect LICs to rise over the medium term from their current unsustainable low levels, but they should remain easily manageable. Fitch considers the group's capitalisation is in line with its risk profile. Risk-weighted capital ratios have remained broadly stable over the past few years and internal capital generation is sound given the bank's good track record of stable profitability. Leverage remains higher than peers with a reported leverage ratio of 4.1% at end-2016, supported by the issuance of GBP1.5bn of additional Tier 1 capital securities. SGH is targeting a long-term leverage ratio of 4.5%, which we believe to be achievable given its track record of recurring internal capital generation and access to wholesale markets if required. SGH's funding and liquidity profile is good. The bank is predominately deposit-funded with a large stock of stable customer deposits representing just over three-quarters of end-2016 total non-equity funding, excluding derivatives. The continued success of the bank's 123 current account has led to an increased inflow of retail deposits and a gradual improvement in the bank's loan-to-deposit ratio. The bank also has good access to wholesale funding, which is diversified through the use of various funding programmes and the regular issuance of secured funding. The minimum requirement for own funds and eligible liabilities set by the Bank of England, equivalent to 26% of the bank's RWAs by 2022, suggests that the group will be an active issuer of eligible debt over the next few years, as the Santander group is likely to adopt a multiple point of entry resolution strategy. We have assigned a DCR to San UK and ANTS due to their significant derivatives activity. 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) SGH's and San UK's SRs reflect Fitch's opinion that there is a high probability of extraordinary support from their ultimate parent, Banco Santander if needed. This probability of support indicates a 'BBB+' Long-Term rating floor based on institutional support. The SR reflects Fitch's view that Banco Santander has a strong propensity to support its UK subsidiaries, but in our opinion, its ability to provide support is constrained by the subsidiaries' large size. Our view that the parent's propensity to support is strong is primarily based on the strategic importance of the UK business to Banco Santander and the high reputational risk associated with failure to support UK operations. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The ratings of all subordinated debt and hybrid securities issued by SGH and San UK are notched down from the respective banks' VRs, reflecting a combination of Fitch's assessment of their incremental non-performance risk relative to the VR (up to three notches) and assumptions around loss severity (up to two notches). These features vary considerably by instrument. SGH's fixed rate reset perpetual additional Tier 1 capital securities and San UK's non-cumulative preferred shares are rated five notches below the respective banks' VRs to reflect the higher than average loss severity risk of these securities (two notches) and higher risk of non-performance as coupon payments are fully discretionary (three notches). Legacy Tier 1 securities, including those issued by Abbey National Capital Trust 1 and guaranteed by San UK, are rated four notches below San UK's VR to reflect higher loss severity risk (two notches) and higher risk of non-performance due to discretionary coupon payments (two notches). Legacy upper Tier 2 securities are rated three notches below San UK's VR (one for loss severity and two for non-performance). Legacy dated Tier 2 instruments are notched down once from the VR for loss severity. SUBSIDIARY COMPANY - ABBEY NATIONAL TREASURY SERVICES The IDRs of ANTS, until recently the UK group's main debt issuing vehicle, are based on support and are equalised with those of SGH and San UK. ANTS's obligations are guaranteed by San UK and all proceeds are up-streamed to the parent. San UK became issuer of the group's senior debt effective 1 June 2016. RATING SENSITIVITIES IDRS, VRS, DERIVATIVE COUNTERPARTY RATING AND SENIOR DEBT The Stable Outlook indicates our view that an upgrade of San UK's and SGH's VRs and IDRs is unlikely in the near term and would require further diversification of the bank's business model through the expansion of the retail, commercial and larger corporate franchises while maintaining its modest risk appetite. The VRs and IDRs could come under pressure if the group increases its risk appetite, for example, through more aggressive expansion into commercial lending, or if its capitalisation or asset quality weakens materially, none of which Fitch currently expects. The VRs and IDRs are also sensitive to a material worsening of underlying earnings and asset quality if the economic environment deteriorates substantially following the UK's decision to leave the EU. San UK's Long-Term IDR could be notched up once from its VR when sufficient senior debt is down-streamed in a manner which is subordinated to other senior creditors of San UK from its parent company, SGH, to recapitalise the bank to a viable level after a failure without having to bail in other senior creditors at San UK. The uplift would be influenced by Fitch's assessment of the direct and indirect linkages between San UK's and Banco Santander's risk profiles, which typically constrains a subsidiary's VR to no more than three notches above a parent's IDR. Fitch believes that San UK's reputation and business flows are to some extent correlated with the overall creditworthiness of the parent Banco Santander. Consequently we believe there should be a difference of maximum two notches between the VR of SGH and the Long-Term IDR of Banco Santander. San UK's ratings are therefore also sensitive to changes to the parent's IDR. Fitch does not expect changes related to the requirement of establishing ring-fenced banks in the UK to affect San UK's ratings. In December 2016, the group announced that it intends to maintain the majority of its operations within the ring-fenced bank, San UK. Activities that by law cannot be undertaken by a ring-fenced bank, and which in the case of San UK are only a small part of its overall business, will be transferred to Banco Santander's UK branch. The group had previously planned to transfer a material portion of its business into a non-ring-fenced bank, ANTS, and to maintain in San UK only those activities that by law have to be included in a ring-fenced bank. SGH's VR and IDRs would be downgraded if double leverage increases materially, which we do not expect. The DCR is sensitive to changes in San UK's Long-Term IDRs. SR The SR is sensitive to both a change in the strategic importance of the UK banking group to its parent, which we currently do not expect, and in Banco Santander's ability to provide extraordinary support. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital ratings are primarily sensitive to changes in the VRs of the issuers or their parents. The securities' ratings are also sensitive to a change in their notching, which could arise if Fitch changes its assessment of the probability of their non-performance relative to the risk captured in the issuers' VRs. This may reflect a change in capital management in the group or an unexpected shift in regulatory buffer requirements, for example. The ratings are also sensitive to a change in Fitch's assessment of each instrument's loss severity, which could reflect a change in the expected treatment of liability classes during a resolution. SUBSIDIARY COMPANIES - ABBEY NATIONAL TREASURY SERVICES (ANTS) ANTS's ratings are primarily sensitive to changes in San UK's IDRs. The future role of ANTS in the SGH group is likely to change as a result of the changed ring-fencing plans, but we do not expect that the group's propensity to support ANTS will reduce as a result. The full list of rating actions is as follows: Santander UK Group Holdings plc Long-Term IDR: affirmed at 'A'; Outlook revised to Stable from Positive Short-Term IDR: affirmed at 'F1' Viability Rating: affirmed at 'a' Support Rating: affirmed at '2' Senior unsecured debt long-term rating, including programme rating: affirmed at 'A' Senior unsecured debt short-term rating, including programme rating affirmed at 'F1' Subordinated debt: affirmed at 'A-' Subordinated notes and fixed rate reset perpetual additional Tier 1 capital securities: affirmed at 'BB+' Santander UK plc Long-Term IDR: affirmed at 'A'; Outlook revised to Stable from Positive Short-Term IDR: affirmed at 'F1' Viability Rating: affirmed at 'a' Support Rating: affirmed at '2' Derivative counterparty rating assigned at 'A(dcr)' Senior unsecured debt long-term rating, including programme rating: affirmed at 'A' Senior unsecured debt short-term rating, including programme rating and commercial paper: affirmed at 'F1' Market-linked senior unsecured securities: affirmed at 'Aemr' Subordinated debt: affirmed at 'A-' Upper Tier 2 subordinated debt: affirmed at 'BBB' GBP300m non-cumulative, callable preference shares, XS0502105454: affirmed at 'BB+' Other preferred stock: affirmed at 'BBB-' Abbey National Treasury Services plc Long-Term IDR: affirmed at 'A'; Outlook revised to Stable from Positive Short-Term IDR: affirmed at 'F1' Support Rating assigned at '1' Derivative counterparty rating assigned at 'A(dcr)' Senior unsecured debt long-term rating, including programme ratings: affirmed at 'A' Senior unsecured debt short-term rating: affirmed at 'F1' Abbey National Capital Trust 1 USD1bn trust preferred securities (ISIN: US002927AA95) (guaranteed by San UK): affirmed at 'BBB-' Contact: Primary Analyst Joanna Drobnik, CFA Director +44 20 3530 1318 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Marc Ellsmore Associate Director +44 20 3530 1438 Committee Chairperson Bjorn Norrman Senior Director +44 20 3530 1330 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: elaine.bailey@fitchratings.com. 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