OREANDA-NEWS. Fitch Ratings has affirmed Newcastle Building Society's (NBS) Long-Term Issuer Default Rating (IDR) at 'BB+' with a Stable Outlook, Short-Term IDR at 'B' and Viability Rating (VR) at 'bb+'. At the same time, Fitch has withdrawn NBS's ratings. Fitch has withdrawn the ratings for commercial reasons. A full list of rating actions is at the end of this rating action commentary.

KEY RATING DRIVERS

IDRS, VR AND SENIOR DEBT

NBS's IDRs and VR primarily reflect the society's limited franchise and the concentration of its business on the UK housing market. The ratings are also based on low profitability, weak capital generation and the limited ability to absorb unexpected losses as a result. The ratings further consider the society's healthy asset quality, adequate capitalisation, stable funding and sound liquidity.

Asset quality is healthy, with an impaired loans/gross loans ratio of 1.8% at end-2015, but lending is concentrated in UK mortgages. Over recent years asset quality has improved due to the reduction of impaired loans and conservative provisioning levels, leading to a reduced tail risk from unreserved impaired loans. We consider this to be an important development given the society's still weak internal capital generation.

NBS maintains a strong appetite for high loan-to-value (LTV) mortgages, where spreads are higher. Fitch considers this risk to be well managed, with all mortgages with an LTV of over 80% covered by a Mortgage Indemnity Guarantee. We expect loan-impairment charges (LICs) to rise, but to be maintained at low levels due to sound underwriting standards. The society no longer has any appetite for commercial loans or lending to professional buy-to-let investors and both these books are in run-off.

The society's member business remains loss-making but losses continue to narrow. NBS has generated weak profitability and capital since the financial crisis as a result of high LICs related to the society's legacy commercial loans, and its large stock of low-risk but low-yielding housing association loans.

The recent improvement in profitability has been driven by lower funding costs and lower LICs. The latter have been falling since 2012, underpinned by a supportive operating environment, sound underwriting and deleveraging of legacy commercial loans. However, underlying profitability is still well below the sector average. As a result, LICs continue to absorb a much higher proportion of pre-impairment operating profit than its peers.

As a fee-driven business, NBS's savings management business, Strategic Solutions, adds diversification to the core member business. Although revenue was negatively affected by lower demand for retail funding in 2014 and 1H15 due to the availability of the UK government's Funding for Lending Scheme (FLS), it has recovered, driven by a larger client base and an increase in deposits as FLS balances reduce. Fitch expects this to continue for the full year 2016 due to a strong pipeline of new business.

Capitalisation is adequate for NBS's rating. Regulatory capital ratios are in line with higher-rated peers, but we consider capitalisation to be weaker at NBS due to the low absolute size of capital and weak internal capital generation. On a non-risk-weighted basis, the society compares well with peers, with a reported fully-loaded leverage ratio of 4.5% at end-1H16. Given the society's extremely limited access to capital, the society's capital flexibility will depend on stronger capital generation, aided by the member business returning to sustainable profitability.

Liquidity is sound, although we expect it to gradually reduce as the balance sheet begins to grow. High-quality liquid assets mostly comprise cash at the Bank of England, highly rated RMBS and covered bonds. The society also benefits from access to contingent funding from the Bank of England. Customer deposits account for the majority of the society's funding. The society's loan-to-deposit ratio is low by sector standards, reflecting its limited use of wholesale funding and slow loan growth.

SUPPORT RATING (SR) AND SUPPORT RATING FLOOR (SRF)

NBS's SR and SRF reflect Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities in the event the society becomes non-viable. In our opinion, the UK has implemented legislation and regulations that provide a framework that is likely to require senior creditors to participate in losses for resolving NBS.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

NBS's subordinated debt is notched down once from the VR for loss severity.

RATING SENSITIVITIES

Not applicable.

The rating actions are as follows:

Long-term IDR affirmed at 'BB+'; Outlook Stable and withdrawn

Short-term IDR affirmed at 'B' and withdrawn

Viability Rating affirmed at 'bb+' and withdrawn

Support Rating affirmed at '5' and withdrawn

Support Rating Floor affirmed at 'No Floor' and withdrawn

Subordinated notes affirmed at 'BB' and withdrawn