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Fitch Affirms Leeds Building Society at 'A-'; Stable Outlook
May 8, 2017 / 2:07 PM / 7 months ago

Fitch Affirms Leeds Building Society at 'A-'; Stable Outlook

(The following statement was released by the rating agency) LONDON, May 08 (Fitch) Fitch Ratings has affirmed Leeds Building Society's (LBS) 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 LBS 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 LBS's IDRs, VR, DCR and senior debt ratings reflect the society's sound, albeit weakening, profitability, adequate asset quality, solid capitalisation, and sound funding and liquidity. They also reflect an appetite for higher-risk segments, the society's limited franchise and the concentration of its business on the UK housing market. LBS's profitability weakened in 2016 as competition in the mortgage market intensified, resulting in lower retention rates and pressure on the society's reported net interest margin, which fell from 162bps in 2015 to 137bps in 2016. We expect further margin erosion in 2017 due to persistent low interest rates and limited scope to reduce funding costs further. Nonetheless, the society's profitability remains sound driven by good cost efficiency and the composition of the loan book, which includes an above-average exposure to higher-yielding, higher-risk specialist segments, such as shared ownership. The profitability is also supported by strong levels of mortgage retention and strong back book profitability due to a higher-than-average administered rate. LBS's underwriting standards are generally in line with the sector, but with a higher appetite for specialist mortgage lending. Net loan growth was very high, at 17% in 2016, well in excess of peers and significantly outpacing internal capital generation. We do not believe that loan growth was driven by a relaxation of underwriting standards and expect loan growth to slow. Continued growth at current levels could put pressure on capital ratios and lead to less favourable risk-adjusted returns given strong competition in the mortgage market. Asset quality is sound and compares well with its UK peers. However, we believe that LBS's loan book is higher risk than that of similarly-rated building societies peers, due to an above-average appetite for lending to sectors we view as more vulnerable in an economic downturn. LBS's gross impaired loans ratio was slightly above average of Fitch-rated societies at end-2016 (1.3% of gross loans), reflecting the society's legacy exposures, which include commercial lending in the UK and mortgages extended in Spain and Ireland. The society's shared ownership and buy-to-let portfolios continue to perform well, supported by a so far benign operating environment and the low LTVs of these loans. Capital ratios weakened slightly in 2016 because of fast loan growth, but they remain solid and comfortably above minimum regulatory requirements. The society's fully-loaded common equity tier 1 (CET1) ratio was 15.2% at end-2016, calculated under the standardised approach, while its regulatory leverage ratio was 5.2%, at the same date. Both ratios compare well with its peer group. We expect capital ratios to decline moderately in 2017 because of further planned business growth, but the society plans to maintain sound capitalisation, in line with regulatory requirements. On-balance sheet liquidity is strong and is supported by contingent liquidity, if required, through central bank facilities at the Bank of England and the European Central Bank (via the society's Irish operations). Lending is mostly funded through a stable customer deposit base supplemented by good access to wholesale markets, both secured and unsecured. LBS's strong liquidity drives the society's 'F1' Short-Term IDR, which is the higher of the two Short-Term IDRs that map to the society's Long-Term IDR. We have assigned a DCR to LBS because it is a counterparty to Fitch-rated covered bonds 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) LBS'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 LBS's subordinated debt is notched down from the VR, reflecting Fitch's assessment of their incremental non-performance risk relative to the VR and loss severity. The permanent interest-bearing shares (PIBS) are rated four notches below the VR: two notches for their deep subordination and two notches for incremental non-performance risk in the form of potential non-payment of coupon. RATING SENSITIVITIES IDRS, VR, DERIVATIVE COUNTERPARTY AND SENIOR DEBT RATINGS LBS's IDRs, VR, DCR and senior debt ratings would come under pressure if further sharp loan growth indicates an increased risk appetite, or if lending to higher-risk segments, including commercial real estate, or higher loan-to-value lending increases materially. The ratings are also sensitive to structural deterioration in profitability, through tighter margins, higher loan impairment charges and lower cost efficiency, and weaker asset quality and capitalisation. This could be caused by continued rapid loan growth or 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. 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 savings market, as less diversified than that of its more highly rated UK peers. The DCR is sensitive to changes in LBS'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 LBS. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES The ratings are primarily sensitive to changes in the VR from which they are notched. The 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 VR. 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. 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 debt and programme rating: affirmed at 'A-'/'F1' Permanent Interest-Bearing Shares: 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 Marc Ellsmore Associate Director +44 20 3530 1438 Committee Chairperson Christian Scarafia Senior Director +44 20 3530 1012 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on 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. 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