Fitch Revises Nationwide Building Society's Outlook to Positive; Affirms at 'A'
OREANDA-NEWS. Fitch Ratings has revised Nationwide Building Society's (Nationwide) Outlook to Positive from Stable. The society's Long- and Short-Term Issuer Default Ratings (IDRs) have been affirmed at 'A' and 'F1', respectively, and its Viability Rating (VR) at 'a'. Fitch has also affirmed Nationwide's Support Rating at '5' and Support Rating Floor at 'No Floor'. A full list of rating actions is available at the end of this rating action commentary.
The revision of the Outlook to Positive reflects Fitch's expectation that Nationwide's junior debt buffer will be increased sufficiently within the next 24 months to protect senior creditors on resolution to warrant a one-notch uplift of the Long-Term IDR above the VR. The society plans to issue Tier 2 debt to meet its minimum requirement for own funds and eligible liabilities (MREL).
KEY RATING DRIVERS
IDRS, VR and SENIOR DEBT RATINGS
Nationwide's IDRs, VR and senior debt ratings reflect 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.
Nationwide is the UK's largest building society with good franchises in the 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 financial year ended 4 April 2016. Commercial and unsecured consumer lending contributed less than 10% of the loan book. Asset quality remains healthy, with low levels of arrears and average indexed loan-to-values (LTVs) and strong diversification by individual borrower.
Nationwide's pre-tax profit increased by 22.5% in FY16, reflecting higher net interest income and low loan impairment charges, which was partly offset by higher costs and provisions. Fitch expects performance to remain resilient to pressure from low interest rates on mortgage and net interest margins.
Nationwide's capitalisation is sound with an estimated Fitch Core Capital/risk-weighted assets (RWAs) ratio of above 25% at end-FY16 (based on preliminary FY16 results). Its reported CET1 and leverage ratio at the same date stood at 23.2% and 4.2%, 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.
Funding benefits from the society's large and stable retail deposit base, 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.
Fitch equalises Nationwide's Long-Term IDR with its VR, but the Positive Outlook reflects our expectation that the Long-Term IDR could be upgraded to one notch above the VR once the society's qualifying junior debt buffer increases further within the next 24 months.
KEY RATING DRIVERS - SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)
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.
KEY RATING DRIVERS - 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 (one or two notches).
Nationwide's 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.
IDRS, VR AND SENIOR DEBT RATINGS
Nationwide's IDRs, VR and senior debt ratings are 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 commercial real estate, 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 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.
The Positive Outlook on Nationwide's Long-Term IDR indicates that the rating could be upgraded by one notch above the VR within the next 24 months if the society continues to increase its qualifying junior debt buffer in the form of AT1 and Tier 2 instruments as planned. Fitch believes that this buffer would be made available to protect senior obligations from default in case of Nationwide's failure, either under a resolution process or as part of a private sector solution, for instance in the form of a distressed debt exchange, to avoid a resolution action.
Nationwide's qualifying junior debt amounted to about 9.3% of RWAs and 1.5% of the society's leverage ratio denominator at end-FY16. On an RWA basis, 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, currently at just above 8% of RWAs. Fitch believes that the group would likely need to meet its pillar 1 and pillar 2A total capital requirements (currently around 14.4% of RWAs), as well as its 2.5% capital conservation buffer and 1% systemic risk buffer immediately after a resolution action. This means a post resolution action CET1 requirement of about 18% of post-recapitalisation RWAs could be needed under a bail-in scenario.
Fitch's assessment of the regulatory intervention point and post-resolution capital needs taken together suggest a junior debt buffer of just below 10% of RWAs could be required to restore viability without hitting senior creditors, which is only slightly higher than the available qualifying junior debt buffer at end-FY16.
Given the low average risk weighting of Nationwide's assets and potentially high RWA volatility Fitch has also assessed the sufficiency of the society's qualifying junior debt buffers in the (currently more likely) event of a resolution resulting from a breach of a 3% regulatory leverage ratio. In such a stressed scenario, we would expect a higher RWA density but also lower pillar 2 requirements and thus a lower post-resolution capital requirement. In Fitch's opinion, a qualifying junior debt buffer of at least 2% of Nationwide's RWAs could be necessary to recapitalise the society to a leverage ratio with comfortable headroom above the minimum regulatory requirement and to an adequate post-resolution RWA-based capital ratio.
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: affirmed at 'A'; Outlook revised to Positive from Stable
Short-Term IDR: affirmed at 'F1'
Viability Rating: affirmed at 'a'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'No floor'
Senior unsecured long-term debt, including programme ratings: affirmed at '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+'