OREANDA-NEWS. Fitch Ratings, London, 30 June 2016: Fitch Ratings has affirmed Coventry Building Society's (CBS) Long - and Short-Term Issuer Default Ratings (IDR) at 'A'/'F1', Viability Rating (VR) at 'a', Support Rating at '5' and Support Rating Floor at 'No Floor'. The Outlook is Stable.

The rating actions are part of Fitch's periodic review of the UK Building Societies.

KEY RATING DRIVERS

IDRS, VR AND SENIOR DEBT RATINGS

The IDRs, VR and senior debt ratings reflect the society's low risk appetite, driven by its focus on low-risk, low loan-to-value (LTV) prime residential mortgage loans and buy-to-let (BTL) mortgage loans. This has resulted in stable and healthy asset quality. Its business model is based on maintaining consistent profitability through a low-margin, low-cost, low loan impairment charges business model. This low-risk appetite has a high influence on the society's VR.

Asset quality remains strong and is at the top end of its peer group driven by low levels of impaired loans and low loan impairment charges (LICs). Although the society has a small portfolio of legacy commercial and specialist residential loans, which are the result of a merger with a small building society in 2010, these are in wind-down and are in our opinion not a material risk to asset quality.

Reserve coverage of impaired loans is low by sector standards but reflects the low average LTV of its loan book, and write-offs have been minimal.

Profitability has proved resilient in a low interest-rate environment, despite the society's undiversified income sources. Fitch expects net interest margins to have reached maximum levels with mortgage loan yields tightening due to increased competitive pressure and funding costs are likely to have bottomed out. A key component of the society's ability to maintain its business model is its ability to control costs. This is driven in part by the society's limited branch network, which we believe is a competitive advantage in times of heightened competition in the mortgage markets.

CBS reports strong regulatory capital ratios due to the low-risk nature of its loan book and sound internal capital generation. The CET1 ratio was 29.4% at end-2015, calculated on an internal ratings-based approach. While low risk weights assigned to its loan book do not, in our view, underestimate the risk profile of its loans, it has resulted in high leverage. Nevertheless, we consider leverage to be adequate, with a 4% regulatory leverage ratio at end-2015.

Liquidity is strong with liquidity buffers composed of cash at the Bank of England and UK government bonds. It also benefits from access to contingent liquidity from the Bank of England. CBS is mainly deposit-funded, but it also has accessed wholesale funding, with covered bonds, senior unsecured and subordinated debt outstanding. The society has also accessed funding through the government's Funding for Lending Scheme.

Fitch equalises CBS' Long-Term IDR with its VR despite significant layers of subordinated debt. We have not given any uplift to CBS's Long-Term IDR relative to the VR because the society's Long-Term IDR would not achieve a higher level than the current 'A' if CBS's junior debt buffer was in the form of Fitch Core Capital (FCC) rather than debt. This is primarily because we believe that the society's company profile, as a monoline mortgage lender, constrains the VR at 'a'.

SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)

The society'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. 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 the society.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

The society's subordinated debt is notched down from the VR, reflecting Fitch's assessment of their incremental non-performance risk relative to the VR and assumptions around 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.

The society's AT1 securities are rated five notches below its VR, comprising two notches for loss severity to reflect the conversion into core capital deferred shares (CCDS) on breach of a 7% CRD IV common equity Tier 1 (CET1) ratio, and three notches for non-performance risk, reflecting the instruments' fully discretionary interest payments.

RATING SENSITIVITIES

IDRS, VR AND SENIOR DEBT RATINGS

CBS's IDRs, VR and senior debt ratings are sensitive to an increase in its risk appetite, which could give rise to higher LICs, or through an increase in its cost base, either of which could lead to a material weakening in operating profitability. The society's ratings could also come under pressure if higher regulatory capital requirements, which could include a potential capital floor on BTL risk-weighting based on the revised standardized approach, put pressure on its low-risk business model.

The VR and IDRs could also be affected by materially adverse developments following the UK decision to leave the EU. Fitch believes earnings and asset quality reached cyclical highs in 2015 and the ratings are resilient to a moderate weakening of these factors. However, a negative rating action could be triggered by a severe and structural deterioration of the UK operating environment, leading to material downward pressure on profitability, through tighter margins and higher LICs, and weaker asset quality. A weakening of the prospects for BTL lending would put CBS's ratings under pressure given the society's exposure to this segment, which however is of high quality.

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 the savings market, as less diversified than that of its more highly rated UK peers.

SUPPORT RATING AND SUPPORT RATING FLOOR

An upgrade of the society'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 VRs from which they are notched. 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'

Senior unsecured EMTN programme and notes affirmed at 'A'/'F1'

PIBS affirmed at 'BBB-'

Additional Tier 1 securities affirmed at 'BB+'