DBRS Confirms Nationwide at A (high), Trend Stable

DBRS Ratings Limited (DBRS) confirmed the ratings of Nationwide Building Society (Nationwide or the Society), including its A (high) Long-Term Senior Debt and Long-Term Deposits Rating. The trend on all ratings is Stable. The Intrinsic Assessment (IA) for Nationwide is A (high), whilst the support assessment remains SA3. As a result, the
Society’s final ratings are positioned in line with the IA.

Nationwide’s ratings and the Stable trend reflect the strength of the Society’s domestic retail franchise, which is underpinned by its solid positions in residential mortgage lending and savings products. The ratings also incorporate the Society’s satisfactory profitability, strong capital position, sound and well-managed funding and liquidity profile, which is supported by the substantial retail deposit base, as well as the solid credit quality of the Society’s mortgage book, which has consistently proven to be significantly better than the industry.

Despite a trend of improving statutory earnings in recent years, in FY17 Nationwide’s earnings generation weakened, with statutory profit before tax down 18% YoY, to GBP 1,054 million. The Society's performance in FY17 was in line with management expectations and followed an introduction of a financial performance framework in 2016, under which Nationwide seeks to achieve the right balance between distributing value to members and maintaining financial strength. Underlying profit before tax in FY17 was GBP 1,030 million, a 23% decrease year-on year (YoY). The decline in underlying profitability was due to a decline in net interest income due to margin pressures, combined with increases in expenses and impairment provisions. Underlying costs were on the rise, driven by growth of employee costs, higher business volumes and investments in customer propositions and efficiency. Impairment losses increased to GBP 140 million as a result of enhancements to credit loss provisioning methodology and assumptions which resulted in additional residential mortgage impairments.

During the quarter ending June 2017 (first quarter of FY18), underlying profit before tax declined by 18% YoY to GBP 301 million, predominantly due to a large one-off gain in the quarter ending June 2016 (gain on the sale of the Society’s investment in Visa Europe). Adjusted for the impact of business disposals, the profit was broadly consistent with the prior period. DBRS positively notes the net interest margin (NIM) stabilisation at 1.35%, comparable with the FY17 level (1.33%), which combined with volume growth contributed to YoY growth of net interest income. Costs were up, largely driven by higher pension costs and impairment losses were also higher than in the same period last year. Given the current low interest rate environment and competition in core markets, pressure on margins is likely to be maintained and DBRS will continue to closely monitor the Society’s profitability.

The asset quality of the residential mortgage portfolio remains a key rating strength for Nationwide, reflecting the sound risk management approach, supportive economic conditions and a continued low interest environment. Given a very low level of arrears in the mortgage book, a further decline is unlikely, in DBRS’ opinion. Prime residential mortgage loans continued to perform well, with an impaired loan ratio of only 0.27% at end-FY17, broadly stable from a year earlier. The “Specialist” book (comprising buy-to-let, self-certification and other non-standard mortgage lending) has also performed well with impaired loans remaining on a downward trend and reducing to 1.21% from 1.28% during FY17. The average LTV of the residential loan portfolio remained at 55%. The lending risk of the commercial real estate (CRE) portfolio, which Nationwide is holding and actively managing to maturity, continued to improve. In DBRS’ view, the political and economic uncertainty resulting from the Brexit vote remains one of the main risks to Nationwide’s asset quality.

DBRS continues to view Nationwide’s liquidity and funding profile as strong, supported by a well-established position in retail savings, good access to wholesale markets and significant liquidity buffers. Nationwide remains predominantly retail funded, in line with its strategy and regulations. During FY17 the Society maintained good access to wholesale markets. At end-FY17, 66% of wholesale funding had a residual maturity in excess of one year, up from 59% at end-FY16. Nationwide’s liquidity position also remained strong, with end-FY17 liquid assets (on and off balance sheet) of GBP 27.5 billion consisting largely of Cash and UK Gilts. Cash, Government Bonds and Supranational Bonds included within the liquid asset buffer represented 129% of total wholesale funding maturing within one year assuming no rollovers.

Nationwide continues to report improving and very strong capital ratios, as a result of recent strong earnings generation and the continued deleveraging of CRE assets. At end-FY17, Nationwide reported a fully-loaded Common Equity Tier 1 (CET1) ratio of 25.4%, an increase of 220 basis points (bps) YoY, driven by internal capital generation and a decrease in RWAs. The total capital ratio increased by 520 bps to 36.1%, additionally supported by the issuance of USD 1.25 billion of qualifying Tier 2 subordinated debt, aimed at meeting the anticipated Minimum Requirement for Own Funds and Eligible Liabilities (MREL). The UK leverage ratio was 4.4%, flat YoY. The CRR leverage ratio also remained stable at 4.2%.

The comparison of indicative MREL requirements published by the Bank of England in May 2017 and Nationwide’s estimate of MREL resources at end-FY17 translates into a manageable shortfall to the interim requirement. In DBRS’ opinion, Nationwide is well positioned to meet the MREL requirements by continued issuance of Tier 2 capital, or, if legislative changes allow, through issuance of senior non-preferred instruments. During 2016 Nationwide comfortably passed the PRA’s third concurrent stress test of the UK banking system, which assumed severe stress of the UK economy and the housing market.

The Grid Summary Grades for Nationwide Building Society are as follows: Franchise Strength – Strong; Earnings – Good; Risk Profile – Strong; Funding & Liquidity – Very Strong/Strong; Capitalisation – Strong.

RATING DRIVERS
Upward pressure on the ratings is unlikely given the already high rating level. Increased franchise and earnings diversification, whilst maintaining a prudent risk profile, would likely be required before the ratings could be upgraded.

Negative pressure could result from a failure to maintain an acceptable level of consistent profitability, a significant deterioration in the UK housing market, or if DBRS were to perceive any weakening in its franchise, risk profile or capital buffer.

Notes:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017). This can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial and Company Documents. DBRS considers the information available for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance

For further information on DBRS historical default rates published by the European Securities and Markets
Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Tomasz Walkowicz, Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, MD – Head of EU FIG, Global FIG
Initial Rating Date: December 9, 1998
Last Rating Date: July 14, 2017

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