DBRS Confirms Nationwide BS’s Long-Term Issuer Rating 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 on 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 take into account the strength of the Society’s domestic retail franchise in the United Kingdom (UK) and its solid positions in residential mortgage lending and savings products. The ratings also incorporate the Society’s satisfactory profitability, the strong capital and loss absorbing capacity, and the sound and well-managed liquidity and funding profile, which is supported by the substantial retail deposit base. The credit quality of Nationwide’s mortgage book, which represents the majority of the Society’s overall lending, is strong and has consistently proven to be better than the industry average.

RATING DRIVERS
Upward pressure on the ratings could arise from improved cost efficiency, as well as indications the Society can sustain current trends and maintain sound asset quality in a less favourable market and economic environment.

Negative pressure could result from a failure to maintain an acceptable level of consistent profitability, or a material deterioration in asset quality. A substantial negative impact of the UK’s exit from the EU on the Group’s risk profile could also exert downward pressure on the ratings.

RATING RATIONALE
Nationwide’s significant franchise in the UK is an important factor considered in the ratings. Nationwide is the UK’s largest building society with a substantial high street presence across the UK. As a building society, Nationwide is predominantly a residential mortgage lender and deposit taker, however, it also offers a wider range of retail banking products similar to the large commercial banks.

In FY19 Nationwide maintained its healthy underlying earnings generation, which benefits from its solid domestic franchise and the focus on low risk mortgage lending. As a mutual, Nationwide aims to optimise, not maximise, profits and to offer good long-term value to its members. In FY19 (this incorporates the financial year ending April 4, 2019) Nationwide’s statutory profit before tax (PBT) was down 15% to GBP 833 million and the underlying PBT, which excludes the Financial Services Compensation Scheme costs and gains or losses from derivatives and hedge accounting, was GBP 788 million, declining 19% YoY. The decline in profits was mainly due to the expenses incurred from a 5-year investment programme launched in 2018 which is targeted at the simplification of the Society’s IT infrastructure and the enhancement of digital service and data capabilities. This contributed to an 11% increase in operating expenses. While the strategic investment is likely to exert negative pressure on the Society’s cost-to-income ratios in the near to medium term, it should allow Nationwide to improve operational efficiency and responsiveness to customer needs in the future, in DBRS’ opinion. Despite the continued margin pressure in the mortgage lending business, underlying income remained resilient in FY19. Impairment losses increased by 8% YoY, driven by higher consumer banking and commercial lending provisions, in part offset by a net reversal in the residential lending book, and the change from accounting under IAS 39 to IFRS 9.

The asset quality of the residential mortgage portfolio remains a key rating strength for Nationwide, reflecting the Society’s sound risk management approach and the low interest rate environment. The overall loan portfolio consists primarily of UK prime residential mortgages, which account for 76% of loans and advances to customers. The rest of the portfolio largely consists of specialist mortgage lending (17%), commercial and other lending (5%) and consumer banking (2%). Prime residential mortgage loans continue to perform very well. The share of impaired exposures was a very low 0.50% and the average LTV of the prime mortgage stock was 57% at end-FY19. The credit performance of Nationwide’s other loan books remained healthy over the last year. Legacy conduct issues have had a limited impact on the Society and market risk is low.

DBRS continues to view Nationwide’s liquidity and funding profile positively, supported by a well-established position in retail savings, good access to wholesale markets and significant liquidity buffers. The Society is one of the UK’s largest providers of savings, with a 10.1% market share of UK retail deposit balances (as of March 2019) and its market share of new current account openings during FY19 strengthened to 16.2%. At FY19 the ratio of loans to deposits as reported by Nationwide remained broadly stable at 125.2%. On-balance sheet wholesale funding as a proportion of total funding increased slightly to 28.6% at FY19 from 28.2% at FY18. This increase was driven by a 4% growth in on-balance sheet wholesale financing to GBP 61.2 billion, of which around one-third was short-term. Nationwide’s liquidity position also remained strong, with FY19 liquid assets of GBP 26.9 billion. Cash, Government Bonds and Supranational Bonds included within the liquid asset buffer represented 120% of total short-term wholesale funding. As a result of the large residential mortgage portfolio, the Society has the capacity to increase its stock of self-issued mortgage backed securities and covered bonds if necessary.

The Society’s capital and leverage ratios continue to be well in excess of regulatory requirements and the leverage requirements represent the binding capital constraint for Nationwide. On 30 June 2019, Nationwide’s Common Equity Tier 1 (CET1) was a very strong 31.4%. The UK leverage ratio was 4.4%, declining from 4.9% at end-FY19, mainly due to the redemption of an AT1 capital instrument. DBRS notes that Nationwide’s requirement on a UK leverage basis increased to 4% from 1 August 2019, due to an additional leverage ratio buffer of 0.35%, aligned to the implementation of the systemic risk buffer under the PRA rules. DBRS notes that over the last year Nationwide strengthened its loss absorbing capacity through continued issuance of senior non-preferred debt. On 30 June 2019, the Society’s MREL resources were 7.9% of UK leverage ratio exposure (equivalent to 55.8% of RWAs). MREL resources are well above the anticipated 2020 requirement of 7.25%.

While the Society’s risk-weighted ratios are very strong compared to peers, DBRS notes that the revision of residential mortgage IRB models and the finalisation of Basel III framework will contribute to a significant increase in RWAs and a decline in capital ratios. Despite this, Nationwide expects its post-RWA revision CET1 ratio to remain ahead of domestic peers and its capital should remain constrained by leverage requirements. Nationwide anticipates that the implementation of new residential mortgage IRB models in 2020, following changes required by the PRA, will lead to an increase in RWAs and an estimated reduction in the CET1 ratio of approximately one third. This combined with the additional impact of Basel III reforms which come into effect between 2022 and 2027 is likely to result in an overall expected reduction in the reported CET1 ratio of approximately 45% to 50% (pro-forma impact based on the FY19 ratio of 32.4%). Nationwide expects that the regulatory impact will be in part mitigated by internal capital generation.

Alongside today’s rating action DBRS has discontinued-withdrawn the rating on the Society’s Permanent Interest Bearing Shares for business reasons.

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 (June 2019). This can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Company Documents, the Bank of England and S&P Global Market Intelligence. 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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