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Fitch Affirms Principality Building Society at 'BBB+'; Outlook Stable
May 26, 2016 / 3:33 PM / a year ago

Fitch Affirms Principality Building Society at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, May 26 (Fitch) Fitch Ratings has affirmed Principality Building Society's (PBS) Long- and Short-Term Issuer Default Ratings (IDRs) at 'BBB+'/'F2'. The Outlook is Stable. A full list of rating actions is available at the end of this rating action commentary. KEY RATING DRIVERS IDRs, VRs AND SENIOR DEBT PBS's IDRs, VR and senior debt ratings reflect the society's overall moderate risk profile, improved asset quality, solid capitalisation and sound funding and liquidity. The ratings are however, constrained by a limited franchise and the concentration of its business on the UK housing market. Our assessment of risk appetite takes into account the society's strong focus on core residential mortgage loans and savings business but also reflects PBS's exposure to commercial real estate (CRE) loans and second-charge mortgages. This raises the overall risk profile of PBS given the size of these exposures compared with its capital. Nonetheless, the risk-return of these loans has been strong in the case of second-charge mortgages and is improving in commercial loans. The commercial lending division has been profitable since 2014, after a number of loss-making years. The society has been reducing the proportion of this business to the overall loan book, as core business expands. Second-charge lending is being run off. Asset quality has improved, with falling arrears across all books. CRE includes loans to the Welsh housing association sector, reflecting PBS's role in providing finance for housing in Wales. These loans are performing well but are low-yielding. Concentrations in the legacy commercial loan book have been further reduced to a moderate level, with the top-20 loans accounting for 65% of Fitch Core Capital at end-2015. PBS's profitability is in line with the industry average, reflecting a presence in higher-yielding sectors combined with low returns of both low-risk mortgages and lending to housing associations. We expect operating profitability to have reached maximum levels, with mortgage loan yields suffering from increased competitive pressures and a greater bias towards prime residential mortgage loans, and funding costs likely to have bottomed. Earnings are undiversified. Fitch views capital as adequate for the risks the society assumes, with solid ratios on both a risk-weighted basis and a non-risk weighted basis. The CET1 ratio was 21% at end-2015, calculated partly on an internal ratings-based approach, while the leverage ratio was a sound 5.5% at the same date. Capital has benefited from the sale of subsidiaries over the past two years but is largely generated through retained earnings. We expect these ratios to be maintained with solid buffers over minimum requirements, given the society's limited access to external capital. Funding and liquidity are sound. Funding is obtained largely from customers as the society has a large and stable customer base in Wales, although some diversification is also provided by accessing the wholesale markets, mostly secured (RMBS and Funding for Lending Scheme, FLS). While these have raised asset encumbrance somewhat, it remains modest at 21% of total assets. Fitch expects some additional debt issuance in the medium term to replace FLS maturities, which may take the form of unsecured debt. Liquidity is healthy and of good quality and benefits from strong access to contingent sources. SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF) PBS's SR and SRF reflect Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities in the event PBS becomes non-viable. In our opinion, the UK has implemented legislation and regulations that provide a framework that is likely to require senior creditors to participate in losses for resolving PBS. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES PBS's subordinated debt is notched down from the VR, reflecting a combination of Fitch's assessment of their incremental non-performance risk relative to the VR and assumptions around loss severity. Lower Tier 2 subordinated debt is notched down once from the VR for loss severity. The permanent interest-bearing shares (PIBS) are rated four notches below the VR, reflecting two notches for loss severity and two notches for incremental non-performance risk. RATING SENSITIVITIES IDRs, VRs AND SENIOR DEBT PBS's IDRs, VR and senior debt ratings could be negatively affected by a sharp increase in lending to higher-risk segments, including a significantly larger proportion of higher LTVs or expansion of the commercial and second-charge books. They could also be downgraded if capitalisation becomes non-commensurate with the society's risk profile. Upside potential is limited given the society's small size and undiversified business model, which concentrates on UK residential mortgage lending and savings. PBS's VR and IDRs could be affected by a material change in the operating environment, for example were there to be material economic and financial market fallout from any decision by the UK to leave the EU. SUPPORT RATING AND SUPPORT RATING FLOOR An upgrade of PBS's SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support its banks or building societies. This is highly unlikely, in Fitch's view. 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 'BBB+'; Outlook Stable Short-Term IDR affirmed at 'F2' Viability Rating affirmed at 'bbb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' Senior unsecured debt and programme rating affirmed at 'BBB+'/'F2' Subordinated dated debt affirmed at 'BBB' PIBS affirmed at 'BB' Contact: Primary Analyst Claudia Nelson Senior Director +44 20 3530 1191 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Joanna Drobnik, CFA Director +44 20 3530 1318 Committee Chairperson Christian Scarafia Senior Director +44 20 3530 1012 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: Additional information is available on Applicable Criteria Global Bank Rating Criteria (pub. 20 Mar 2015) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1005163 Solicitation Status here Endorsement Policy here ail=31 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 WEBSITE '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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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