DBRS Confirms The Co-operative Bank plc at “A”, Trend Stable

DBRS, Inc. (DBRS) has today confirmed the ratings of The Co-operative Bank plc (Co-operative or the Bank), including its Long-Term Debt & Deposits rating of ‘A’. The trend on all ratings is Stable.

The ratings and confirmation reflect the Bank’s bolstered franchise which has benefited from the merger with Britannia Building Society (Britannia), its respectable asset quality measures and the sound and well-managed liquidity and funding profile. The merged Bank’s market position, its geographic footprint and high-street presence are notable factors supporting the franchise. Offsetting these strengths is exposure to real estate in the United Kingdom and the integration risks associated with the merger, as well as the Bank’s ability to navigate the challenging operating environment while continuing the positive momentum in underlying financial performance.

The ratings consider the positive benefits derived from the merger of the two complementary franchises. The results of which is reflected in the Bank’s well-balanced retail franchise, complete with an expanded customer base, broader product offerings and increased distribution channels. DBRS recognises the increased scale, depth and presence which allow the Bank to better compete in an increasingly consolidated and competitive market. Although integration is advancing at a good pace, integration risks remain and still pose a challenge. Both the legacy Co-operative and Britannia operate on separate systems; migration to a common banking system is expected by the end of 2013. Completion of systems conversions, without customer service interruption is imperative to a successful integration. While DBRS recognises the notable tasks remaining to complete the integration, given management’s proven track record of successful integrations, the ahead of plan synergies already achieved and overall acumen of management, DBRS expects the three year integration plan to be ultimately successful.

The ratings consider DBRS’s view that underlying earnings generation ability is sound. To this end, for the six months to 30 June 2011, on an underlying basis, which excludes the provision for Payment Protection Insurance (PPI) mis-selling and other costs, the Bank’s operating result increased 37% year-on-year to GBP 108.6 million. While the Bank has achieved a noteworthy improvement in operating results, margins remain constrained by the low interest rate environment. Given the expectations of continued low interest rates and increasingly uncertain economic environment, DBRS is mindful of the Co-operative’s ability to maintain the positive momentum in underlying earnings.

The Bank’s sound asset quality is the foundation of the solid risk profile and an important rating consideration. To this end, credit performance of the residential mortgage loan book continues to trend favourably and importantly, the book is outperforming industry averages for the first time since the merger. Within the prime residential mortgage loan book, which accounts for 68% of the mortgage book, arrears (those with arrears balance greater than 2.5% of the loan balance) remained a very low 0.45% of the book. Arrears in the riskier specialist mortgage book continue to trend lower, but remain elevated. However, given the attributes of this loan book and the uncertainty in the strength of the recovery in both the U.K. economy and housing prices, DBRS remains cautious that improving credit trends could reverse. The performance of the corporate lending portfolio remains within expectations. While DBRS sees the U.K. concentration of the loan book as a concern, the conservative underwriting, focused collection and loss mitigation efforts, and the large prime lending book provides a level of comfort. Moreover, additional comfort is gained by the fair value credit marks on the legacy Britannia book which provide a cushion from increased credit losses.

The ratings consider the well-managed liquidity and funding profile. Customer deposits, which exceed non-securitised loans, provide the foundation of a diversified funding and liquidity profile. Moreover, the Co-operative’s reliance on wholesale funding is modest with only 17% of funding from wholesale sources. Despite market turmoil, the Co-operative maintains good access to the capital markets demonstrated by the GBP 700 million residential mortgage securitisation completed in 1H11 and the issuance of a GBP 600 million covered bond in November 2011. Liquidity remains robust with a liquid asset ratio of 11.5% at the end of June 2011.

At 30 June 2011, the core Tier 1 ratio was 9.6% and the total capital ratio was 14.8%, both of which comfortably exceed the regulatory minimums. Given the Co-operative’s mutual status, which limits the Bank’s ability to raise external capital, DBRS expects the Bank to hold a higher amount of capital than its domestic listed peers. DBRS views The Co-operative’s ability to navigate the current cycle without the need to raise additional capital as illustrating the Bank’s conservative lending culture and the soundness of its balance sheet.

The Stable trend reflects DBRS’s opinion that, although the recovery in the U.K. economy and housing market may be uneven over the near-term, the Co-operative is well-positioned to withstand these headwinds. Going forward, DBRS is looking for a successful integration of the two franchises, and continued and increasing evidence that the Bank is capturing the benefits of the merger.

Note:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include DBRS’s criteria for Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

Lead Analyst: Steven Picarillo
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 10 August 2009
Most Recent Rating Update: 6 August 2010

For additional information on this rating, please refer to the linking document under Related Research.