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 Issuer Rating and its R-1 (middle) Short-Term Issuer Rating. The trend for all ratings is Stable. Nationwide’s Intrinsic Assessment (IA) is A (high), while its Support Assessment remains SA3 and its Long-Term Issuer Rating is positioned in line with the Society’s IA.

KEY RATING CONSIDERATIONS
Nationwide’s ratings and the Stable trend reflect the strength of the Society’s domestic retail franchise in the UK, 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.

RATING DRIVERS
Positive rating pressure could arise from improved cost efficiency, as well as indications the Society can sustain current trends and maintain the resilience of the UK mortgage book in a less favourable market and economic environment.

Negative pressure could result from a failure to maintain an acceptable level of consistent profitability, or if the risk profile increased. Potential adverse economic effects of the UK’s exit from the EU on the Society’s risk profile could also exert downward pressure on the ratings.

RATING RATIONALE
In FY18 Nationwide maintained its healthy underlying earnings generation, which remained in line with the Society’s financial performance framework, under which it seeks to optimise its profit in order to retain sufficient earnings to support future growth, sustain a strong capital position and retain capacity to invest in the business. Underlying profit before tax (PBT) was GBP 1,022 million, marginally down 1% year-on-year (YoY), due to a decline in underlying income, which was only partly offset by reduced impairment losses and provisions. Underlying income was GBP 3,132 million, slightly down due to a debt buy-back exercise charge of GBP 116 million and the non-recurrence of a one-off gain of GBP 100 million from the sale of the investment in Visa Europe in the previous year. Net interest income increased 2% YoY to GBP 3,011 million, as lower funding costs were largely offset by reduced mortgage income due to competitive pressures on margins in the mortgage market. Efficiency improvement remains a priority for Nationwide. The Society targets GBP 300 million of sustainable cost savings to be delivered by 2022. Reflecting the focus on cost containment, underlying costs remained stable YoY at GBP 1,979 million, despite solid growth in business volumes. Impairment losses remained low and have further reduced to GBP 105 million in FY18.

During the quarter ending June 2018 (first quarter of FY19), underlying profit before tax declined by 10% YoY to GBP 270 million, mainly reflecting the non-recurrence of a one-off gain in the quarter ending June 2017 (gain on the sale of the Society’s investment in VocaLink). Pressure on net interest margin (NIM) continued from FY18. 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 Society’s sound risk management approach, supportive economic conditions and a continued low interest rate environment. Given a very low level of arrears in the mortgage book, their further decline is unlikely, in DBRS’ opinion. Prime residential mortgage loans continue to perform very well, with an impaired loan ratio of only 0.26% at end-FY18, broadly stable from a year earlier. Increased lending for first time buyers resulted in a higher share of this segment in new lending, while the average loan to value (LTV) of new origination remained stable at 71% in FY18 and the average LTV of the portfolio remained also relatively stable at 56%. Due to an increased focus on first time buyers, the proportion of the portfolio with an LTV above 80% increased to 11.2% (end-FY17: 9.6%). The maximum LTV for new prime residential customers is 95%. 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 1.11%, from 1.21% at end-FY17.

At end-FY18 Nationwide held provisions of GBP 221 million for potential costs of remediation and redress, of which GBP 159 million were provisions in relation to past sales of Payment Protection Insurance (PPI). In FY18, the Society took a charge of GBP 28 million in relation to PPI (FY17: GBP 128 million), driven by an increase in the anticipated volume of complaints expected, following the Financial Conduct Authority (FCA) media campaign.

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. Nationwide’s focus on growing its base of members led to a retail deposit increase by 1% to GBP 148.4 billion. However, given robust 4% growth YoY in residential mortgages, the ratio of loans to deposits (including shares, other deposits and amounts due to customers) as reported by Nationwide was 125.5% at end-FY18, an increase from 122.6% a year earlier. During FY18, the Society maintained good access to wholesale markets. At end-FY18, 73% of wholesale funding had a residual maturity in excess of one year, up from 66% at end-FY17. Nationwide’s liquidity position also remained strong, with end-FY18 liquid assets (on and off balance sheet) of GBP 26.8 billion, consisting largely of Cash and UK Gilts. Cash, Government Bonds and Supranational Bonds included within the liquid asset buffer represented 142% of total wholesale funding maturing within one year assuming no rollovers.

Nationwide continues to report strong and improving capital ratios, as a result of recent solid earnings generation and the Core Capital Deferred Shares (CCDS) issuance in September 2017. At end-FY18, Nationwide reported a fully-loaded Common Equity Tier 1 (CET1) ratio of 30.5%, an increase of 510 bps from a year before. The increase was primarily driven mainly by internal capital generation and a GBP 0.8 billion of CCDS issuance. During FY18 risk-weighted assets (RWAs) have declined by 3.4% to GBP 32.5 billion, mainly driven by the continued run-off of the CRE book. The total capital ratio increased by 680 bps to 42.9%, additionally supported by the net issuance of GBP 0.6 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 4.9%, up 50 bps YoY due to the increase in Tier 1 capital and the issuance of CCDS. The CRR leverage ratio also increased at 4.6%. In March 2018 Nationwide made an inaugural issuance of senior non-preferred notes, which it considers to be MREL eligible. Including GBP 2.1 billion of outstanding senior non-preferred notes at end-FY18, the Society’s MREL resources were around 7.5% of UK leverage ratio exposure, meeting the interim MREL requirement, expected at 6.5% of UK leverage exposure, plus the applicable buffers, which are subject to change but are currently expected to amount to 0.75% of leverage exposure from 1 January 2019. In DBRS’ opinion, Nationwide is well positioned to meet the MREL requirements through further issuance of senior non-preferred debt.

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

Notes:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018). This can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Company Documents, SNL Financial and the Bank of England. 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, Managing Director – Head of EU FIG, Global FIG
Initial Rating Date: December 9, 1998
Last Rating Date: September 8, 2018

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