DBRS Comments on Nationwide Building Society’s Interim Results at AA (low), Trend Stable

DBRS, Inc. (DBRS) has today commented on Nationwide Building Society’s (Nationwide or the Group) interim results for the half year ending 30 September 2012 (1H FY13). DBRS rates the Group’s Long-Term Debt and Deposits at AA (low). The trend on all ratings is Stable. For 1H FY13, Nationwide reported a statutory profit before tax of GBP 124 million compared to a profit before tax of GBP 238 million in the comparable period a year ago. One of the factors impacting results was a negative hedge accounting and derivative fair value adjustment compared to a gain a year ago. On an underlying basis, excluding the fair value adjustment, restructuring costs, and FSCS costs and bank levy, Nationwide reported a profit before tax of GBP 151 million, 17% lower than the year ago period. Income (revenue) growth was 14%, but underlying results were lower primarily due to an increase in provision charges related to payment protection insurance (PPI) and commercial property lending.

In a challenging economic environment, DBRS sees Nationwide’s results as providing further evidence as to the strength of the franchise and the resilient earnings ability afforded by the franchise. Within Nationwide’s core residential mortgage lending business, the Group continues to gain market share in an overall weak and sluggish market. Nationwide advanced GBP 10.2 billion of mortgages in 1H FY13, the Group’s highest six month lending period in four years. As a result, the Group’s share of gross lending was 14% while its first-time buyer market share expanded to 18%. Illustrating the Group’s success in expanding its presence in consumer financial services, Nationwide opened 184,200 new current accounts in 1H FY13 increasing the Group’s share of this market to 7.1%. In addition, Nationwide’s credit card business continues to grow with the Group’s market share increasing to almost 4%. DBRS continues to monitor these segments to ensure new business growth does not lead to any weakening in underwriting standards.

Pressure on net interest margins has been a key challenge for Nationwide, but repricing efforts and margin widening on core retail products supported the first expansion in net interest margin (NIM) since the onset of the low base rates and underpinned the solid underlying results. As a result of this margin expansion and growth in average interest earning assets, total underlying income increased 14% year-over-year (YoY) to GBP 1.1 billion. Net interest income was 17% higher YoY at GBP 909 million reflecting higher margins on new business volumes and repricing efforts at deal maturity as well as growth in the lending book. At 30 September 2012, NIM was but 12 bps higher YoY at a still low 93 bps. Net interest income also benefited from GBP 69 million of gains derived from management of the liquidity portfolio, GBP 48 million from the release of excess credit fair value adjustments related to the acquisitions of regional brands and net accounting adjustments of GBP 22 million. DBRS views the expansion in NIM positively and will look to Nationwide’s ability to sustain the positive trajectory in a challenging market. Nationwide continues to advance its strategy of expanding its banking product offerings in order to improve the diversity of its revenue generation profile, and DBRS notes Nationwide’s underlying other income grew 5% YoY to GBP 223 million.

Costs continue to be well-controlled with underlying costs increasing 1.7% YoY to GBP 655 million. The increase reflects higher technology related depreciation and related run-rate costs as Nationwide continues to invest strategically to position the Group for long-term growth. Further, regulatory related costs continue to contribute to the higher costs. Solid revenue growth which outpaced the growth in costs resulted in the Group’s cost income ratio declining to 57.9% in the quarter, compared to 65.1% a year ago. For 1H FY13, Nationwide reported a PPI provision charge of GBP 45 million compared to GBP 15 million a year ago. Similar to industry peers, the increase reflects the higher volume of PPI complaints across the industry. DBRS notes that Nationwide commented that a significant portion of the increase in complaints relates to cases where there was either no sale of a policy or no evidence of mis-selling. Nevertheless, given the uncertainty of future volumes of claims, Nationwide made the additional provision to cover the estimated cost of redress and associated administration on claims they expect to uphold.

Retail credit performance remains stable and continues to outperform industry averages. At 30 September 2012, residential mortgage loans comprised total 84% of Nationwide’s GBP 157.2 billion gross loans and advances. Residential mortgage arrears (three months or more) moderated to a very low 0.70%, less than half of the industry average. Reflecting Nationwide’s conservative lending culture, the indexed LTV of the residential mortgage book stood at 50% unchanged from fiscal year-end. Residential mortgage impairments were 38% lower at GBP 26 million, reflecting the strong underlying quality of the loan book and the Group’s conservative underwriting guidelines. Credit performance in the GBP 20.9 billion commercial lending portfolio (of which GBP 11 billion comprises commercial property) weakened in 1H FY13, reflecting weak economic conditions in the U.K. and falling values in the property markets. Arrears, by cases, increased 72 basis points to 4.38%, while total arrears balances grew to GBP 75 million from GBP 58 million at fiscal year-end. Commercial impairments increased significantly to GBP 193 million from GBP 72 million a year ago and 10% on a half-year linked basis. The higher impairment charge reflects the recessionary environment in the U.K. and continuing uncertainties regarding the Eurozone debt crisis both of which are suppressing tenant demand and investor demand in the sector. Given the uncertainties regarding the near-term path of the U.K. economy, DBRS remains cautious regarding credit performance and as such sees credit costs remaining above historical levels over the near-term.

Nationwide’s balance sheet remains sound supported by a well-managed liquidity and funding profile and solid capitalisation. The Group’s funding profile is underpinned by its substantial retail deposit base. At 30 September 2012, retail deposits stood at GBP 125.1 billion, and account for over 75% of total funding. Evidencing Nationwide’s prudent management of funding, the Group noted that it has no plans to access the wholesale markets in the current fiscal year as the fiscal year’s wholesale funding maturities of GBP 4.9 billion were pre-funded in fiscal year 2011/2012. Moreover, the Group has access to inexpensive funding through the U.K. Government’s Funding for Lending Scheme (FLS). Recent changes to the U.K. liquidity regime have allowed Nationwide to manage down its level of core liquidity, but remain in excess of regulatory requirements. At 30 September 2012, core liquidity totalled GBP 20.0 billion, down GBP 4.5 billion from fiscal year-end, but still 143% of short-term funding. Regarding capital, Nationwide’s Basel II Core Tier 1 ratio stood at 12.4% largely unchanged from 4 April 2012. Nationwide has indicated it expects to issue a Core Tier 1 instrument in 2013.

Notes:
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 the Enhanced Methodology for Bank Ratings – 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 and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following that disclosure.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: Alan G. Reid
Initial Rating Date: 9 December 1998
Most Recent Rating Update: 19 March 2012

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