DBRS Confirms Nationwide Building Society at AA, Trend Remains Negative

DBRS has today confirmed Nationwide Building Society’s (Nationwide or the Group) ratings, including its AA Long-Term Senior Debt & Deposit rating. 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 is Stable.

Today’s confirmation of the AA rating reflects Nationwide’s strong national franchise, its solid, largely retail funded balance sheet, and its strong capital base. Further, the rating confirmation considers Nationwide’s solid revenue generation ability, which gives the Company the capacity to absorb the elevated credit costs associated with the current phase of the economic cycle. DBRS’s ratings on Nationwide reflect its position as the largest building society in the U.K. Nationwide maintains top tier market share in both the savings and mortgage-lending markets.

Although profitable for FY 2009, which ended in April 2009, preliminary results indicate that pre-tax profit was GBP 212 million, down 69% from the prior fiscal year. Nationwide’s results were pressured by several factors that DBRS considers non-recurring. During the year, the Group recorded a charge of GBP 241 million related to the Financial Services Compensation Scheme (FSCS) levy, GBP 107 million in transformation costs driven by the integration of Portman, Cheshire and Derbyshire building societies into the Group, and a GBP 157 million gain on business combinations. Removing the impact of these non-reoccurring items, underlying profit fell 50% to GBP 393 million. Results indicated significant weakness during the second half of FY 2009, as the UK economic environment deteriorated. Despite the lower underlying earnings, DBRS views the overall solid results achieved in the current challenging operating environment as an illustration of the overall strength of the Company’s franchise and its strong earnings generation power, both of which underpin the current rating.

Net interest income was pressured by the Company’s decision to hold a higher level of high-grade liquidity during the recent market volatility and the elevated costs of retail funding resulting from increasing competition. Net interest margin fell to 0.93% with a 4 basis point (bps) reduction attributed to higher levels of liquidity, 5 bps attributed to the reduction in the base Libor differential, and 10 bps attributed to increased cost of funding and the decline in retail spread. Margins are expected to continue to decline given the ongoing low base rate environment and the cost of Government sponsored schemes.

Despite credit quality being impacted by increasing levels of unemployment and declining home values, overall Nationwide’s loan book continues to perform better than the market, which DBRS attributes to sound underwriting and loan servicing ability. Nonetheless, asset quality deteriorated during the year, particularly during the second half of FY 2009. Impairments increased significantly from the prior year to GBP 394 million as the challenging operating environment pressured the residential and commercial loan portfolios. For Nationwide originated residential mortgage loans, accounts three months or more in arrears was 0.60% at 4 April 2009, compared with the industry average of 2.39% at 31 March 2009. The Group’s very modest unsecured lending portfolio has experienced an increase in over 30-days in arrears to 7.15% from 5.88% a year ago, but again, remains favourable compared to the industry average. Nationwide’s commercial loan book, approximately 14.5% of the loan portfolio, continues to perform within expectations, with a provision as a percentage of assets at 0.92% compared with 0.15% a year ago.

DBRS considers Nationwide’s capital position as sound. On an IRB basis, the Group’s core Tier 1 and Tier 1 ratios were 12.1% and 15.1%, respectively, as of 4 April 2009. Accordingly, DBRS views the Group’s ability to withstand the current environment without the need to raise additional capital as evidencing the Group’s prudent lending culture and the robustness of its balance sheet.

Nationwide’s funding profile remains well-managed and strong. The Group continues to be less reliant on the wholesale funding markets than other U.K. financial institutions with over 70% of funding via retail deposits. Additionally, Nationwide’s loan-to-deposit ratio improved to 112.4% from 117.2% a year ago; as additional funding was primarily used to enhance the liquidity portfolio. Nationwide maintains a sizeable liquidity portfolio, which totalled GBP 31.1 billion at 4 April 2009.

The Negative trend reflects DBRS’s concerns that Nationwide’s earnings will remain under pressure in the near-term as unemployment in the U.K. continues to increase and home price deflation continues.. Given the Group’s exposure to the deteriorating U.K. housing market and economy, DBRS anticipates earnings power to be suppressed during the recessionary environment; thereby pressuring the Group’s earnings before impairments, which are key to absorbing elevated credit costs associated with a downturn in the economic cycle. Although, DBRS has a level of tolerance for reduced earnings, losses which reduce the Nationwide’s capital cushion could add negative pressure to the ratings Moreover, DBRS believes that there is a degree of integration risk present as the Group integrates its recent acquisitions of the Cheshire, Derbyshire and Dunfermline building societies. However, DBRS takes comfort from Nationwide’s demonstrated ability to successfully integrate past acquisitions that enhance the Group’s franchise, which underpins the rating.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.

Notes:
All amounts in GBP unless otherwise noted.

The applicable methodologies are, Analytical Background and Methodology for European 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.