DBRS Comments on Nationwide’s Interim Results, Long-Term at AA, Trend Negative

DBRS has today commented that Nationwide Building Society’s (Nationwide or the Group) ratings, including its Long-Term Senior Debt & Deposits rating of AA, remain unchanged following the Group’s interim results announcement for the six months ended 30 September 2009. The trend on all ratings is Negative, except for the trend on the Commercial Paper rating and the ratings of the debt Guaranteed by HM Treasury, which are Stable.

Today’s comment follows Nationwide’s interim results announcement indicating that the Group earned an underlying profit of GBP 117 million for the half year ended 30 September 2009. Although results evidenced a 64% decline from the comparable period a year ago, importantly, on a linked basis, underlying profit increased 65% over the six months ending 4 April 2009. DBRS views these acceptable results, in the current difficult operating environment, as an illustration of the strength of the franchise and the strength of the Group’s solid earnings generation ability, both of which are reflected in the rating. Of note, net interest margin (NIM) remained relatively flat to the previous six-month period at 0.91%. Excluding treasury gains, NIM would have declined to a rather low 0.83%, evidencing the current distorted pricing for retail deposits in the U.K.

Recording GBP 458 million of earnings before impairments for the half-year period, Nationwide continues to generate sufficient pre-impairment income to absorb the elevated credit costs of the current cycle. Impairment losses on loans and advances to customers totalled GBP 317 million for the half year, which was slightly less than the previous six-month period. Impairment charges decreased to GBP 45 million in the residential mortgage book reflecting the flat arrears levels and a slight increase in U.K. house prices. Meanwhile, the commercial loan book continues to be pressured by business failures, reduced tenant demand, and the decline in property values. Accordingly, impairment charges in the commercial lending loan book increased by 23% to GBP 180 million.

Overall credit performance continues to outperform industry averages reflecting the Group’s sound underwriting and loan servicing ability. For Nationwide-originated residential mortgage loans, which total 78.3% loans and advances, mortgage arrears (three months or more) remained a very low 0.66% of the book. Arrears in the specialist mortgage book at 2.39% of the loan portfolio remain in line with industry averages, which include both prime and specialist lending. Specialist mortgages total GBP 18.4 billion, of which GBP 15.3 billion are Nationwide-originated, and remain a manageable 11.9% of total loans and advances. The performance of the commercial lending portfolio continues to weaken. Arrears in the loan book increased to 2.34% of the loan book from 1.62% at 4 April 2009.

Liquidity and funding remains solid. Retail deposits remain the primary source of funding, representing approximately 70% of total funding. Nationwide remains the second largest savings provider in the U.K. with a deposit book of GBP 122.7 billion. However, retail deposits experienced an outflow of GBP 5.6 billion during the six months ended 30 September 2009, as the Group maintained its prudent approach to pricing discipline. Further, enhancing liquidity is the sizeable liquidity portfolio maintained by the Group of GBP 31.1 billion. Capital remains very solid with core Tier 1, Tier 1 and Total Capital ratios at 12.0%, 15.0% and 19.1%.

In maintaining the Negative trend, DBRS notes that uncertainties remain in this environment presenting continuing risks and reflects DBRS’s ongoing concern that the recovery in the U.K. economy remains tenuous. As such Nationwide’s earnings will remain under pressure in the near-term, as any economic recovery is likely to be protracted. Moreover, rising unemployment continues to threaten the recent upswing in housing prices and it is still unclear if the commercial real estate markets have stabilised. Nonetheless, DBRS is looking for further evidence that the recent signposts suggesting that the operating environment has improved are sustainable. Finally, the Negative trend reflects DBRS’s concern that a structural shift in margins may be occurring in the U.K. due to competitive distortions in the pricing of customer deposits. While DBRS anticipates margin compression to continue over the near-term owed to the current interest rate environment, ratings could be negatively pressured should DBRS become convinced that the current shift in margins is permanent and not cyclical.

Notes:
All amounts in GBP unless otherwise noted.

The applicable methodologies are, Analytical Background and Methodology for European Savings Bank Ratings, Second Edition and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.