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Fitch Upgrades Nationwide Building Society to 'A+'; Outlook Stable
February 7, 2017 / 5:22 PM / 10 months ago

Fitch Upgrades Nationwide Building Society to 'A+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, February 07 (Fitch) Fitch Ratings has upgraded Nationwide Building Society's (Nationwide) Long-Term Issuer Default Rating (IDR) to 'A+' from 'A' and affirmed the society's Viability Rating (VR) at 'a'. Fitch has also affirmed Nationwide's Support Rating at '5' and Support Rating Floor at 'No Floor'. The Outlook is Stable. A full list of rating actions is at the end of this rating action commentary. The Long-Term IDR has been upgraded to one notch above the VR to reflect Fitch's view that Nationwide's qualifying junior debt (QJD) buffers are now sufficiently large to provide protection for senior unsecured creditors in case of the society's failure. In addition, Fitch has assigned a Derivative Counterparty Rating (DCR) to Nationwide as part of its roll-out of DCRs in western Europe and the US. DCRs are issuer ratings and express Fitch's view of an issuer's relative vulnerability to default under derivative contracts with third-party, non-government counterparties. The ratings actions are part of a periodic portfolio review of major UK banking groups rated by Fitch. KEY RATING DRIVERS IDRS, DERIVATIVE COUNTERPARTY RATING AND SENIOR DEBT Nationwide's Long-Term IDR and senior debt ratings are one notch above the society's VR because we believe the risk of default on senior obligations, as measured by the Long-Term IDR, is lower than the risk of the society failing, as measured by its VR. The one-notch uplift reflects a significant qualifying junior debt (QJD) buffer, which could be made available to protect senior obligations from default in case of failure, either under a resolution process or as part of a private sector solution (ie, distressed debt exchange) to avoid a resolution action. Without a private sector solution, we would expect a resolution action being taken on Nationwide when it is likely to breach its pillar 1 and pillar 2A CET1 capital requirements. On a risk-weighted basis, these are currently just above 8% of risk weighted assets (RWA). Fitch believes that the society would need to meet its pillar 1 and pillar 2A total capital requirements (currently around 14.5% of RWAs), as well as its 2.5% capital conservation buffer and 1% systemic risk buffer immediately after a resolution action given its domestic systemic importance. This means a post-resolution action total capital requirement of about 18% of (post recapitalisation) RWAs is reasonable under a bail-in scenario. Fitch's view of the regulatory intervention point and post-resolution capital needs taken together suggest a junior debt buffer of around 10% of RWAs could be required to restore viability without hitting senior creditors. At end-September 2016 (end-1HFY17), the QJD buffer amounted to around 12.5% of RWAs, which should be sufficient to restore the society's viability without hitting senior creditors (taking into consideration Fitch's view of the regulatory intervention point and post-resolution capital needs). Fitch believes that because of Nationwide's low RWA-density and the potential volatility of the society's RWAs in stress scenarios it is appropriate to also assess the society's likely recapitalisation if a resolution is the result of a breach of a 3% regulatory leverage ratio. In this case, a recapitalisation to a leverage ratio well above minimum requirements would be possible with the current available junior debt buffer excluding AT1 instruments, which amounts to about 1.5% of the society's leverage ratio denominator. In this scenario, the QJD would also be sufficient to recapitalise the society to a sufficient total capital ratio. We expect that the society will further strengthen this junior debt buffer and replace maturing instruments. This is in line with its stated target of meeting its minimum requirement for own funds and eligible liabilities (MREL) with subordinated debt. The Short-Term IDR of 'F1' maps to the lower of the two options of the 'A+' Long-Term IDR. While Fitch believes Nationwide's funding and liquidity is solid, it is not exceptional for its rating level, and the Long-Term IDR benefits from a one-notch uplift above the VR. A DCR has been assigned to Nationwide because the society acts as derivative counterparty to Fitch-rated transactions. The DCR is at the same level as the Long-Term IDR because derivative counterparties have no definitive preferential status over other senior obligations in a resolution scenario. VR Nationwide's VR reflects a conservative risk appetite, a leading market position in mortgage lending in the UK, the society's healthy asset quality, sound funding and liquidity and good capitalisation. The VR also reflects Nationwide's business model, which concentrates on mortgage lending and is therefore less diversified than that of other bank peers. Nationwide is the UK's largest building society with strong franchises in retail mortgages and savings. Residential mortgages account for approximately 90% of the society's total loans. About 80% of mortgage loans related to prime owner-occupied mortgages and 18% to buy-to-let (BTL) mortgage loans at end-1HFY17. Commercial and unsecured consumer lending make up the rest of the loan book. In November 2016, the society announced it will no longer be extending credit in its commercial real estate (CRE) business following a strategic review. The society has been reducing its CRE portfolio over the last few years, and at end-1HFY17 total loans outstanding in its CRE business amounted to GBP2.8 billion, or 1.5% of total gross loans. Impaired loans remain low as the society continues to benefit from a continued low-risk business model and benign economic conditions in the UK. Asset quality remains healthy with a gross impaired loan ratio of 0.6% at end-1HFY17. Asset quality benefits from low average indexed loan-to-values (LTVs) and a highly fragmented loan book. Asset quality remains vulnerable to the high indebtedness of UK households, but in Fitch's opinion, this risk is somewhat mitigated by the sound performance of the UK's mortgage market with low base rates supporting affordability. The expected economic slowdown ensuing from the vote to leave the EU could result in weakening asset performance if house prices fall. However, the society's focus on low LTVs, strong underwriting standards as well as the low base rates should allow Nationwide to be resilient to moderate deterioration. Profitability has proved sustainable despite low interest rates and a fairly undiversified income stream with operating profits representing 3.7% of RWAs in 1HFY17. Nationwide posted 1HFY17 pre-tax profit of GBP696 million, 13% lower than in 1HFY16, reflecting lower net interest income, higher costs and an increase in impairment charges. However, the society is on track to meet its intended full-year target for underlying profit of GBP1 billion-GBP1.5 billion. Fitch expects performance to remain resilient despite pressure from intensifying competition in the UK mortgage market. Nationwide's capitalisation is sound with a Fitch Core Capital/ RWAs ratio of 26.2% at end-1HFY17. Its reported CET1 and leverage ratios at the same date stood at 23.3% and 4% respectively, comfortably above minimum requirements (currently 8.1% and 3%, respectively). The society's RWA-based capital ratios partly reflected the low average risk-weights of a high quality mortgage book, which means that the leverage ratio is a binding constraint for the society. Internal capital generation has traditionally been a key factor in Nationwide's capitalisation given the limited options available to mutual building societies for raising core capital externally. Nationwide has reported steady profit over the years, which has helped its core capital ratios. Fitch views the society's funding and liquidity as solid and stable. Funding benefits from the society's large and stable retail deposit base, which represented 71.5% of total non-equity funding at end-1HFY17, but Nationwide also uses wholesale funding, both secured and unsecured. Primary liquidity, mainly in the form of cash and high quality treasury bills, remains sound. In November 2016, the Bank of England published its policy statement for the UK MREL framework. Nationwide expects to comply with the interim requirements applicable to the society from 1 January 2020, expected to be 6% of leverage exposures plus capital buffers. The society has stated that it will meet this requirement through issuance of Tier 2 instruments. SUPPORT RATING AND SUPPORT RATING FLOOR Nationwide's SR and SRF reflect Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities in the event Nationwide becomes non-viable. In our opinion, the UK has implemented legislation and regulations that provide a framework requiring senior creditors to participate in losses for resolving even large banking groups. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Nationwide's subordinated debt and hybrid securities are notched down from the society's VR, reflecting their incremental non-performance risk relative to the VR (up to three notches) and assumptions around loss severity (up to two notches). Nationwide's legacy lower Tier 2 subordinated debt is notched down once from the VR for loss severity. The permanent interest-bearing securities (PIBS) are rated four notches below Nationwide's VR, reflecting two notches for their deep subordination and two notches for incremental non-performance risk. The AT1 securities are rated five notches below Nationwide's VR, of which two notches are for loss severity to reflect the conversion into core capital deferred shares on breach of the trigger, and three notches for incremental non-performance risk as coupon payment is fully discretionary. RATING SENSITIVITIES IDRS, DERIVATIVE COUNTERPARTY RATING AND SENIOR DEBT As the Long-Term IDR and senior debt ratings are notched up from Nationwide's VR, they are sensitive to a change in the bank's VR. The Long-Term IDR and senior debt ratings would be downgraded if the size of the QJD buffer is reduced materially. The notching of the ratings from the VR is also sensitive to changes in assumptions on resolution intervention point and post-resolution capital needs, and the development of resolution planning more generally. Furthermore, changes to Nationwide's risk weightings may also affect the size and sufficiency of the society's junior debt buffer and as such an increase in risk weightings will be negative. The DCR is primarily sensitive to changes in Nationwide's Long-Term IDR. VR Nationwide's VR is primarily sensitive to an increase in the society's risk appetite, which Fitch does not expect. A sharp increase in lending to higher-risk segments, including CRE, or higher LTV lending, could put pressure on its ratings. The ratings would also come under pressure if Nationwide fails to maintain sound capitalisation. An upgrade of Nationwide's VR is unlikely as the society's business model, which concentrates on UK residential mortgage lending and savings, is less diversified than that of its more highly rated UK peers. Nationwide's VR could also be affected by a material change in the operating environment, for example, in the UK if the economic effect of the UK's decision to leave the EU is particularly severe, which may lead to a material worsening of underlying earnings and asset quality. SUPPORT RATING AND SUPPORT RATING FLOOR An upgrade of Nationwide'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, which 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 of the AT1 instruments are also sensitive to Fitch changing its assessment of the probability of their non-performance relative to the risk captured in Nationwide's VR. This could occur if there is a change in capital management or flexibility, or an unexpected shift in regulatory buffers. 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: upgraded to 'A+' from '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 long-term debt, including programme ratings: upgraded to 'A+' from 'A' Commercial paper and short-term debt, including programme ratings: affirmed at 'F1' Lower Tier 2: affirmed at 'A-' Permanent interest-bearing securities: affirmed at 'BBB-' Subordinated additional tier 1 instruments: affirmed at 'BB+' Contact: Primary Analyst Christian Scarafia Senior Director +44 20 3530 1012 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Aabid Hanif Associate Director +44 20 3530 1786 Committee Chairperson Bjorn Normann Senior Director +44 20 3530 1330 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, 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 _id=1018681 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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