Morningstar DBRS Confirms Nationwide’s Long-Term Issuer Rating at A (high), Stable Trend Maintained Further to the Announcement to Acquire Virgin Money UK
Banking OrganizationsDBRS Ratings Limited (Morningstar DBRS) confirmed the credit 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 credit ratings remains Stable. Nationwide’s Intrinsic Assessment (IA) is A (high), while its Support Assessment remains SA3. See a full list of credit ratings at the end of this press release.
KEY CREDIT RATING CONSIDERATIONS
Today’s credit rating action follows the announcement on March 21, 2024 of the boards of directors of Nationwide and Virgin Money UK PLC (Virgin Money or VM, not rated by Morningstar DBRS) that they have agreed the terms of a recommended cash acquisition of VM in full by Nationwide. VM is valued at approximately GBP 2.9 billion which represents a premium of approximately 38% to the closing price on March 6, 2024. While the binding offer to acquire VM is subject to regulatory approval and VM shareholders’ vote, the acquisition is currently expected to become effective during Q4 2024.
The confirmation of Nationwide’s credit ratings considers that Nationwide has a robust domestic retail franchise as well as strong financial fundamentals. Nationwide’s profitability was solid in H1 23/24 thanks to higher net interest margins whilst asset quality remains resilient despite increased borrowing costs.
In addition, if the acquisition of VM by Nationwide goes ahead, Morningstar DBRS considers the combined entity would maintain solid credit fundamentals, and that the IA of the combined entity would remain well placed at its current level of A (high). The acquisition would secure Nationwide’s position as the second largest mortgage lender in the UK. Morningstar DBRS views the addition of VM would not generate material synergies given no material staff changes, meanwhile VM has some business lines with a higher risk profile, such as UK credit cards and business banking. However, the acquisition would mean Nationwide would be somewhat more diversified although still largely remaining reliant on mortgage lending and the UK economy. Morningstar DBRS considers that Nationwide’s funding and liquidity profile would remain underpinned by a solid retail deposit base. Furthermore, the Society’s capital position is expected to remain strong with a pro-forma CET1 ratio estimated at 20%.
Importantly, the integration of VM into the Nationwide group would be gradual over multiple years, and Morningstar DBRS considers this should help to mitigate execution risks. Virgin Money would continue to operate as a separate legal entity within the Nationwide group, with a separate board of directors and a separate banking licence. In addition, Nationwide will remain a building society, and Virgin Money customers would not automatically become members of Nationwide.
CREDIT RATING DRIVERS
An upgrade of the Long-Term credit ratings would require a sustained improvement in profitability whilst maintaining sound asset quality and robust capital levels.
A downgrade of the Long-Term credit ratings would occur if there were material missteps or operational issues with the planned acquisition integration of Virgin Money, or if the combined entities’ credit strength does not remain well placed in the current rating category. In addition, significant deterioration in profitability levels and/or asset quality would result in a credit ratings downgrade.
CREDIT RATING RATIONALE
Franchise Building Block (BB) Assessment: Strong/Good
Nationwide is the largest building society in the UK. Nationwide had total assets of GBP 274.5 billion at end-September 2023 (H1 23/24 with a financial year ending April 4, 2024). The Society has a well-established franchise in the UK, with 17 million customers and with market shares of around 12.2% in mortgages, 9.6% in savings/deposits and 10.4% in current accounts in 2023. While the Society is predominantly a residential mortgage lender and deposit taker, it also offers a wider range of retail banking products similar to the large UK commercial banks.
If the acquisition of VM by Nationwide goes ahead, it would reinforce Nationwide’s position as one of the UK’s leading providers of mortgages, savings and current accounts, as it would rank as the second largest provider of mortgages and savings in the UK after Lloyds Banking Group. The combined entity would represent GBP 366.3 billion in total assets with about GBP 260 billion mortgages (of which 78% from Nationwide), and about 23.6 million customers. In addition, Virgin Money has market shares of around 8.6% in UK credit cards, a business complementary to Nationwide.
Earnings Building Block (BB) Assessment: Good/Moderate
Morningstar DBRS views Nationwide’s earnings generation as good. As a mutual organisation, Nationwide targets profit optimisation rather than maximisation in order to maintain a sound financial position and also to be able to offer long-term value to its members. Nationwide reported a statutory net profit of GBP 989 million in H1 23/24, up 2% year-on-year (YOY) (and GBP 1.66 billion in FY23 up 33% vs. FY22). The Society’s net interest income increased to GBP 2,337 million, up 14% YOY whilst the net interest margin (NIM) improved to 1.66% in H1 23/24, from 1.48% in the first half of last year, and compared to 1.57% in FY23 and 1.26% in FY22. However, NIM remained flat compared to the second half of last year due to fewer base rate change. Meanwhile, Net Other Income reduced as a result of cash back to members through their current accounts.
Nationwide’s underlying cost-to-income ratio improved to 45.5% in H1 23/24 from 49.7% in FY23, and 57.8% in FY22 mainly thanks to higher revenues which more than offset operating costs that increased by 3% YOY partly due to higher staffing costs. Nationwide reported GBP 54 million of loan loss provisions, below GBP 108 million of loan loss provisions reported in the first half of last year. Cost of risk remained low at 3 bps in H1 23/24 compared to 5 bps the prior half year.
Morningstar DBRS considers the planned acquisition of VM would not initially generate material synergies, essentially because there would be no significant staff changes and the integration would be gradual over multiple years. Major changes in the workforce would be evaluated following a comprehensive evaluation of VM by Nationwide and would only be implemented over the medium term. Nationwide will also explore the rationalisation of technology and systems over time. We note VM’s average return on equity (ROE) over the past two years was around 8%.
Risk Building Block (BB) Assessment: Strong/Good
Morningstar DBRS considers Nationwide to have a solid risk profile, underpinned by the sound quality of its UK mortgage book and conservative underwriting standards, with past due mortgages and unsecured lending remaining at low levels. The mortgage book has remained resilient. The new Mortgage Charter, which was announced by the Chancellor and with Nationwide as a signatory, provided additional enhanced support to customers since July 2023 which is easing the pressure of higher mortgage costs. Stage 3 loans remained resilient for the Society and accounted for only 0.76% of gross loans, slightly up from 0.71% at end-FY23, but below 0.81% at end-FY22. Nationwide’s Stage 2 loans are elevated, accounting for 19.9% of the Society’s total gross loan portfolio at end-H1 23/24 up from 17.8% at end-FY23 and 8.8% at end-FY22. The increase in H1 23/24 is mainly driven by Buy to Let mortgages. The average indexed LTV of the mortgage stock was 55% at end-H1 23/24.
Morningstar DBRS views VM as having a higher risk appetite compared to Nationwide, as illustrated by a higher level of loan loss provisions and cost of risk. VM’s cost of risk was 42 bps in FY23, and 35 bps in Q1 2024 (driven by its unsecured/UK credit cards, and business lending). However, the acquisition would mean Nationwide would be more diversified (less of a monoline business), albeit remaining reliant on the mortgage market and UK economy. Lastly, potential execution risks remain for such a large acquisition, but Nationwide has a long term integration strategy which should help to mitigate operational risk issues.
Funding and Liquidity Building Block (BB) Assessment: Strong/Good
Nationwide’s funding profile is sound, supported by a solid position in the domestic deposit market and good access to wholesale capital markets. In line with its strategy and the applicable regulations, Nationwide is predominantly retail funded. Customer deposits (member deposits) increased to GBP 191.3 billion at end-H1 23/24, up 2.2% since end-FY23, with the Society reporting a ratio of net loans to deposits (including shares, other deposits and amounts due to customers) of 106.8% at end-H1 23/24, down from 109.6% at end-FY23. Nationwide had GBP 53 billion liquid assets at end-H1 23/24 as well as GBP 75 billion estimated drawdown facility at the central bank, which compares well to GBP 35 billion of uninsured deposits. In addition, Nationwide reported an average 12-month Liquidity Coverage Ratio (LCR) of 191% in H1 23/24, and an average net stable funding ratio (NSFR) of 149% at end-H1 23/24, both well above the minimum requirement of 100%.
VM’s loan to deposit ratio was 108% at end-Q1 2024, and its LCR was 150% in Q1 2024, with an NFSR ratio of 135%. With the acquisition of VM, Nationwide would have more business deposits although Morningstar DBRS notes these are more volatile in nature.
Capitalisation Building Block (BB) Assessment: Strong/Good
Nationwide had a solid capitalisation position at end-H1 23/24, with a CET1 ratio of 27.4%, up from 26.5% at end-FY23, and 24.1% at end-FY22. This compares very well to the Society’s minimum requirement of 11.5%. The UK leverage ratio was 6.4% at end-H1 23/24, up from 6.0% at end-FY23, and 5.4% at end-FY22. This compares to a minimum requirement of 4.0%.
Morningstar DBRS expects Nationwide's capital position to remain very strong. If the acquisition goes ahead, the pro-forma CET1 is expected to be approximately 20%, and the pro-forma leverage ratio is expected to be approximately 5%. In addition, Nationwide will remain a building society, with the leverage ratio as the binding Tier 1 capital constraint in the medium term. VM’s leverage ratio was 5.1% at end-Q1 2024.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/430261.
ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Social (S) Factors
At present, the social subfactor ‘Social Impact of Product and Services’ is relevant to the credit ratings of Nationwide, but does not affect the overall credit ratings or trend assigned to Nationwide. As a building society, Nationwide is a mutual organisation and is focused on improving the social impact and financial benefits for its members rather than maximising profit. For example, the Society distributed GBP 344 million of profit to eligible members under the Fairer Share Programme and GBP 885 million of member financial benefit in H1 23/24.
There were no Environmental and Governance factors that had a significant or relevant effect on the credit analysis.
A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 (January, 2024) at https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.
Notes:
All figures are in GBP unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 22, 2023) https://dbrs.morningstar.com/research/415978/global-methodology-for-rating-banks-and-banking-organisations . In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings, https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings , in its consideration of ESG factors.
The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.
The sources of information used for this credit rating include Morningstar, Inc. and company documents, H1 2023/2024 Nationwide Presentation, 2.7 Announcement: Recommended Offer for Virgin Money UK PLC by Nationwide Building Society, Virgin Money Annual Report and Accounts 2023, Nationwide Building Society Annual Report and Accounts 2023, Nationwide Annual Results Presentation For the 12 months ended 4 April 2023, Nationwide Building Society Pillar 3 Disclosure 2023, Nationwide Building Society Climate-related Financial Disclosures 2023. Morningstar DBRS considers the information available to it for the purposes of providing this credit rating to be of satisfactory quality.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third-Party Participation: NO
With Access to Internal Documents: NO
With Access to Management: NO
Morningstar DBRS does not audit the information it receives in connection with the credit rating process, and it does not and cannot independently verify that information in every instance.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.
For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/430259.
This credit rating is endorsed by DBRS Ratings GmbH for use in the European Union.
Lead Analyst: Vitaline Yeterian, Senior Vice President European Financial Institutions Ratings
Rating Committee Chair: Elisabeth Rudman, Managing Director - Global Financial Institution Ratings
Initial Rating Date: 25 January 2001
Last Rating Date: 24 July 2023
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