OREANDA-NEWS. Fitch Ratings has affirmed Nationwide Building Society's (Nationwide) Long-term and Short-term Issuer Default Ratings (IDR) at 'A'/F1', respectively, and Viability Rating (VR) at 'a'. Nationwide's Support Rating (SR) and Support Rating Floor (SRF) have been affirmed at '5' and 'No Floor'. The Outlook on the Long-term IDR is Stable. A full list of rating actions is at the end of this comment.

KEY RATING DRIVERS IDRs, Senior Debt and VR
Nationwide's VR and IDRs reflect its low overall risk appetite, strong franchise in the UK mortgage and savings markets; healthy and well performing loan book; conservative funding and liquidity profile and strengthened capital ratios

Nationwide's assets are composed mostly of prime residential and buy-to-let mortgage loans (almost 90% of total loans at FYE15). The residential mortgage lending book has historically performed well and showed improvements in FYE15 in line with the rest of the sector. While still exposed to a higher risk specialist lending book, this now mostly consists of buy-to-let mortgages with low arrear levels.

The society has a conservative attitude toward risk and has made significant progress in de-risking the balance sheet to match its reduced risk appetite. The society reduced its non-core commercial real estate (CRE) portfolio by 64% in the year to 4 April 2015 (FYE15), which had resulted in significant LICs in previous years. The society retains an appetite for CRE lending, but future advances are expected to be modest, of a lower risk profile than previously and targeted at replenishing existing levels. The reduction in CRE exposure, combined with a reduction in some higher risk and now out of policy treasury assets has decreased the society's exposure to tail risk.

Nationwide's strong franchise and brand recognition as the UK's largest building society specialised in mortgage and savings markets is reflected in its conservative funding, which consists predominately of a large and stable retail deposit base. The society also accesses wholesale markets in various forms and these now represent 23% of its total funding. Primary liquidity remains sound and consists of cash and high quality treasury bills.

Capitalisation is solid and strengthened during FYE15 as a result of earnings retention. Regulatory ratios also benefited from a reduction in the expected loss deduction and risk-weighted assets (RWA) following deleveraging of the CRE portfolio. Risk-weighted ratios are higher than those of the major UK banks and benefit from the very low risk weightings of its prime residential mortgage lending. RWA benefit particularly at this point in the economic cycle from the 'point in time' PD approach the society takes. For example, under the PRA's 2014 stress test (which was designed specifically to assess participants' resilience to a severe housing market shock), Nationwide's RWA nearly doubled under the stress scenario; nevertheless its CET1 ratio proved to be resilient. Leverage ratios, which are now more in line with UK major banks but still weaker than most of the building society sector, strengthened to 4.1% at FYE15 from 3.4% a year previously. However, higher levels could still be required by the regulator and we expect the society's leverage ratio to strengthen further.

Profitability has also significantly improved as a result of an enhanced net interest margin, benefiting from low funding costs, reduced impairment charges despite increasing non-operating expenses. Overall, net interest margins are fairly high within the mutual sector, due to reduced funding costs. Fitch considers profitability is now in a sustainable range, although some pressure on net interest margins is expected to arise from increasing competition in the mortgage market.

KEY RATING DRIVERS: SUPPORT RATING AND SUPPORT RATING FLOOR
The SR and SRF reflect Fitch's view that senior creditors can no longer rely on receiving full extraordinary support from the UK sovereign in the event that Nationwide becomes non-viable. Full application of the EU's Bank Recovery & Resolution Directive (BRRD) is required across member states from 1 January 2016, but the UK has already updated its legislative framework with strong policy intent to force losses onto creditors, where necessary.

KEY RATING DRIVERS: SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Nationwide's subordinated debt and hybrid securities are notched down from Nationwide's VR reflecting a combination of Fitch's assessment of their incremental non-performance risk relative to the VR (up to three notches) and assumptions around loss severity (one or two notches).

Nationwide's lower Tier 2 subordinated debt is notched down once from Nationwide's VR for loss severity. The Permanent Interest Bearing Securities (PIBS) are rated four notches below Nationwide's VR, reflecting two notches for their deep subordination and two notches for incremental non-performance risk. The AT1 securities are rated five notches below Nationwide's VR, of which two notches are for loss severity to reflect the conversion into CCDS on breach of the trigger, and three notches for incremental non-performance risk.

RATING SENSITIVITIES
IDRs, SENIOR DEBT and VRs
Given Nationwide's low risk profile and conservative risk appetite, Fitch views its natural VR range to be within the 'a' category. Its relatively narrow business model, which focuses on UK residential mortgage lending and savings, means an upgrade of its Long-term IDR and VR is not Fitch's base case.

The society's ratings are mainly sensitive to an increase in risk appetite (eg, an aggressive rise in lending to riskier sectors, such as CRE, or higher loan to values) or to a material weakening of asset quality. The ratings are sensitive to the society being unable to mitigate unexpected regulatory risk, but this has reduced, following the strengthening of leverage ratios and improvement in internal capital generation.

SUPPORT RATING AND SUPPORT RATING FLOOR
Any upgrade of Nationwide's SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support its banks or building societies. This is highly unlikely, in Fitch's view.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
These ratings are primarily sensitive to changes in Nationwide's VR. The AT1 securities are also sensitive to any change in Fitch's assessment of the probability of their non-performance relative to the risk captured in Nationwide's VR. This could reflect a change in capital management or flexibility or an unexpected shift in regulatory buffers, for example.

The rating actions are as follows:
Long-term IDR: affirmed at 'A' ; Stable Outlook
Short-term IDR: affirmed at 'F1'
Viability Rating: affirmed at 'a'
Support Rating: affirmed at '5'
Support Rating Floor: affirmed at 'NF'
Senior unsecured long-term debt, including programme ratings: affirmed at 'A'
Commercial paper and short-term debt, including programme ratings: affirmed at 'F1'
Lower Tier 2: affirmed at 'A-'
Permanent interest bearing securities: affirmed at 'BBB-'
Subordinated Additional Tier 1 instruments: affirmed at 'BB+'