DBRS Morningstar Confirms Nationwide BS’s Long-Term Issuer Rating at A (high), Stable Trend

DBRS Ratings Limited (DBRS Morningstar) 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 the Long-Term Issuer Rating is positioned in line with the Society’s IA.

KEY RATING CONSIDERATIONS

The confirmation of Nationwide’s A (high) Long-Term Issuer Rating with a Stable trend takes into account the strength of the Society’s domestic retail franchise in the UK and its solid positions in residential mortgage lending and savings products. The ratings also incorporate its solid balance sheet, with strong capital and loss absorbing capacity, and stable funding, supported by a substantial member deposit base. The credit quality of Nationwide’s mortgage book, which represents the majority of overall lending, is strong and has consistently proven to be better than the industry average. The Society’s profitability, despite further weakening in FY2020, remains satisfactory relative to similarly rated peers.
Nevertheless, DBRS Morningstar also notes that Nationwide’s profitability is expected to remain under pressure and its risk profile is likely to deteriorate in FY2021 due to the major economic slowdown in the UK, resulting from the coronavirus pandemic (COVID-19). There is also significant uncertainty around the terms of the UK’s departure from the EU, which in the case of a disorderly exit, could lead to a further deterioration in UK macroeconomic conditions. However, we expect the effects of the economic downturn to be partly offset by the low risk of Nationwide’s loan portfolio, which we expect to remain resilient. Loans consist predominantly of prime mortgages and exposure to higher risk lending is small. We expect the effects of the economic downturn to be partly offset by some of the fiscal and monetary support measures introduced in response to COVID-19. DBRS Morningstar considers that the impact of the COVID-19 outbreak on the Society in the medium to long-term will depend on the depth of the economic crisis. We will continue to monitor the developing situation and its impact on Nationwide’s overall credit profile.

RATING DRIVERS

An upgrade of the Long-Term Issuer Rating is unlikely in the near term, given the challenging economic outlook. However, an upgrade would require a sustainable rebound in profitability over the medium term while maintaining a resilient credit profile.

A further decline in the Society’s profitability combined with a severe deterioration in asset quality, potentially as a result of the economic fallout from COVID-19, would result in a downgrade of Nationwide’s Long-Term Issuer Rating.

RATING RATIONALE

Nationwide’s significant franchise in the UK is an important factor for 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.

As a mutual organisation, Nationwide aims to optimise, rather than maximise, profits and to offer good long-term value to its members. In recent years, Nationwide’s profitability has deteriorated from strong levels as a result of intense competition in mortgage lending and its strategic investment programme. In FY2020 (this refers to the financial year ending April 4, 2020), pressure on profitability intensified, reflecting a combination of provisions for credit losses as a result of COVID-19, additional pressure on net interest income driven by a cut in Bank of England interest rates, and charges related to Payment Protection Insurance (PPI) claims, which surged in the runup to the August 2019 industry-wide deadline for claims. Nationwide’s statutory profit before tax (PBT) in FY2020 was down 44% to GBP 466 million and the underlying PBT, which excludes the Financial Services Compensation Scheme costs and gains or losses from derivatives and hedge accounting, was GBP 469 million, declining 40% YoY. While the Society remained focused on cost efficiency, continuing to deliver additional sustainable cost savings in line with the efficiency programme announced in FY2018, underlying expenses increased, driven by spend on technology and costs related to changes in business banking proposition. This combined with a decline in revenues resulted in the deterioration of the underlying cost-to-income ratio to 75.9% (FY2019: 71.1%).

The asset quality of the residential mortgage portfolio remains a key rating strength for Nationwide, reflecting the Society’s sound risk management. The overall loan portfolio consists primarily of UK prime residential mortgages, which account for 75% of loans and advances to customers. The rest of the portfolio largely consists of specialist mortgage lending (19%), commercial and other lending (4%) and consumer banking (2%). Prime residential mortgage loans continued to perform very well. The share of credit impaired exposures (Stage 3) at end-FY2020 was a very low 0.5%. The average LTV of the prime mortgage stock was 58%, remaining broadly stable YoY. The performance of the residential mortgage book was supported by the resilient performance of the UK housing market to date. According to Nationwide House Price Index, UK house prices in the UK were up 1.5% YoY, recovering from a modest decline in June 2020 (down 0.1% YoY), benefiting from a rapid recovery in housing market activity since the easing of lockdown restrictions and the recently announced stamp duty holiday. The credit performance of Nationwide’s other loan books has been strong. However, given the depth of the economic downturn, driven by COVID-19, we expect some asset quality deterioration in the near to medium term. Pressure on asset quality has been evident in the level of payment and interest holidays extended by Nationwide to its customers. Loans with payment and interest holidays granted due to COVID-19 represented 16% of total residential mortgage outstandings as of April 30, 2020. Legacy conduct issues have had a limited impact on the Society to date and market risk is low.

Nationwide’s funding and liquidity profile is 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 9.9% market share of UK retail deposit balances (as of February 2020) and its market share of all current accounts at 8.1%. The ratio of loans to deposits as reported by the Society was 122.4% (end-FY2019: 125.2%). Wholesale funding as a proportion of total funding remained stable at 28.5%. Nationwide’s liquidity also remained strong. At end-FY2020, on-balance liquid assets were GBP 37.4 billion, increasing from GBP 32.7 billion a year earlier, mainly due to growth in member deposits. Accordingly, the average 12-month Liquidity Coverage Ratio strengthened to 152% at end-FY2020, up from 143% a year earlier.

The Society’ capitalisation is strong and its capital ratios compare favourably with similarly rated peers. The leverage requirements represent the binding capital constraint for Nationwide. On 30 June 2020, Nationwide’s transitional Common Equity Tier 1 (CET1) was a very strong 32.8% compared to 31.9% at end-FY2020 and 32.2% at end-FY2019. The UK leverage ratio was 4.9%, strengthening compared to 4.7% at end-FY2020, mainly due to the issuance of AT1 capital. DBRS Morningstar notes that both the CET1 and UK leverage ratio requirements were well in excess of regulatory capital requirements, which were respectively 12.9% and 3.6%. During FY2020 Nationwide strengthened further its loss absorbing capacity by issuing a further GBP 1.6 billion of MREL eligible senior non-preferred debt. On 30 June 2020, the Society’s MREL resources were 8.6% of UK leverage ratio exposure, above the 2020 regulatory requirement of 6.85%.

While the Society’s risk-weighted ratios are very strong compared to peers, DBRS Morningstar notes that the revision of residential mortgage IRB models combined with the finalisation of Basel III reforms over 2023 - 2028 will contribute to a significant increase in risk-weighted assets (RWAs) and a similarly significant decline in capital ratios. Nationwide anticipates that the implementation of new IRB models, delayed by the Bank of England by one year to January 2022 due to the COVID-19 pandemic, will lead to an increase in RWAs and an estimated reduction in the CET1 ratio by approximately one third The combined impact of the IRB models’ revision and Basel III reforms is likely to result in an overall expected reduction in the CET1 ratio by approximately half compared to current levels. The above regulatory impact extends over a number of years and should be in part mitigated by internal capital generation.

ESG CONSIDERATIONS

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
The Grid Summary Grades for Nationwide Building Society are as follows: Franchise Strength – Strong; Earnings – Good; Risk Profile – Strong; Funding & Liquidity – Very Strong/Strong; Capitalisation – Strong/Good.

DBRS Morningstar notes that this Press Release was amended on 16 September 2020 to incorporate the disclosure for unsolicited ratings.

Notes: All figures are in GBP unless otherwise noted.

The principal methodologies are the Global Methodology for Rating Banks and Banking Organisations (8 June 2020) https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations and the Global Methodology for Rating Non-Bank Financial Institutions (24 September 2019) https://www.dbrsmorningstar.com/research/350802/global-methodology-for-rating-non-bank-financial-institutions

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include Nationwide FY2020 Annual Report & Accounts, Nationwide Annual Results Presentation for the year ended 4 April 2020, Nationwide Preliminary Results Announcement for the year ended 4 April 2020, Nationwide Pillar 3 Disclosure Q1 2020-21, Nationwide House Price Index (July 2020), and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it 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.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar 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 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar 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.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/366225

Ratings assigned by DBRS Ratings Limited are subject to EU and U.S. regulations only.

Lead Analyst: Tomasz Walkowicz, Vice President – Global Financial Institutions Group
Rating Committee Chair: Elisabeth Rudman, Managing Director, Global Financial Institutions Group
Initial Rating Date: December 9, 1998
Last Rating Date: September 2, 2019

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