Fitch Affirms Santander UK, Revises Outlook to Positive
The Long-term IDR of San UK's subsidiary, Abbey National Treasury Services plc (ANTS) has also been affirmed at 'A'/'F1'. A full list of rating actions is at the end of this comment.
The revision of the Outlooks to Positive reflects our expectation that SGH's and San UK's Long-term IDRs could be upgraded to 'A+' over the next12-18 months as its business model becomes more diversified, which should enable the bank's earnings to benefit from the expansion of its retail, commercial and corporate franchises. As its business mix becomes more balanced, the upgrade would be dependent on management maintaining prudent underwriting standards and controls, and on asset quality remaining healthy.
KEY RATING DRIVERS
IDRs, VRs and Debt Ratings
SGH's and San UK's Long-term and Short-term IDRs are driven by our assessment of the group's standalone credit profile, as defined by their VRs. The VRs are underpinned by the group's improving business diversification, conservative risk appetite, healthy asset quality, improving and consistent profitability, sound liquidity and funding profile, and healthy capitalisation. However, the ratings also consider San UK's limited geographic diversification given its focus on the UK and moderate leverage.
Asset quality has been consistently healthy. Impaired loans are very low compared to its UK and similarly rated peers. San UK reports a further measure for problem loans, non-performing loans (NPLs, or loans which are impaired plus all loans 90 days in arrears), which at end-2014 were just 1.8% of gross loans. Retail banking NPLs have remained well below 2.0% of gross loans since 2008. The bank has been deleveraging a legacy commercial real estate and transportation portfolio, which it shrunk by over 30% in 2014. NPLs in this book as well as in its commercial book, continue to decline, reflecting benign economic conditions and rising asset prices.
While we believe that impaired loans might increase slightly with a greater exposure to commercial businesses and consumer finance loans, we expect them to remain modest overall and well covered by reserves. Legacy loans are not expected to cause additional material future losses given current reserve levels.
We consider the bank's funding profile as well balanced, with most funding obtained from customer deposits but also with good access to wholesale markets, both secured and unsecured. Maturities are being extended. Its liquidity cushion is strong.
Regulatory capital ratios are well within current minimum regulatory requirements as at end-June 2015, and while reported leverage ratios were only just adequate at end-1Q15, they are expected to have increased with the issue of AT1 capital securities during June 2015. Capitalisation benefits from the ordinary support of the group's ultimate parent, Banco Santander S.A. (A-/Stable/a-), which feeds into SGH's and San UK's VRs.
SGH and San UK are regulated by the UK PRA and are managed and funded separately from their ultimate Spanish parent. Fitch believes the potential for Banco Santander to upstream excessive liquidity and/or capital would be severely restricted by the UK regulator.
SGH's IDRs and VR are aligned with those of its operating subsidiary San UK, reflecting the high level of liquidity and capital fungibility as well as the currently low holding company double leverage. We expect the holding company to issue an increasing proportion of debt, including AT1s and other hybrid instruments and senior debt. This will result in a debt buffer building up at the holding company over time.
SUPPORT RATING
SGH's and San UK's SRs reflect Fitch's view that support from their ultimate parent, Banco Santander, should it ever be needed, is highly probable. We believe that due to the strategic importance of the UK business to Banco Santander and the high reputational risk associated with failure to support UK operations, Banco Santander would have a high propensity to provide such support. However, the likelihood of providing support is somewhat limited by the ability of Banco Santander to provide such support given the current standalone profile of the parent compared with the size of the UK's balance sheet.
SUBSIDARY COMPANY - ABBEY NATIONAL TREASURY SERVICES (ANTS)
The ratings of ANTS, the UK group's main debt issuing vehicle, are equalised with those of SGH and San UK. ANTS is a fully integrated subsidiary and all its obligations are guaranteed by San UK.
SUBORDINATED DEBT AND HYBRID RATINGS
The ratings of SGH's and San UK's subordinated debt and hybrid securities are notched down from their VRs reflecting 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). These features vary considerably by instrument.
SGH's Fixed Rate Reset Perpetual Additional Tier 1 Capital Securities and San UK's Non-cumulative preferred shares are rated five notches below their VRs to reflect their expected higher loss severity when compared with average recoveries (two notches) and higher risk of non-performance as coupon payments are fully discretionary (three notches).
A number of legacy Tier 1 securities, including those issued by Abbey National Capital Trust 1 and guaranteed by San UK, are rated four notches below San UK's VR to reflect higher loss severity risk (two notches) and higher risk of non-performance as there is some discretion around coupon payments (two notches).
Legacy Upper Tier 2 securities are three notches below San UK's VR (one for loss severity and two for non-performance risk).
Dated Tier 2 instruments are notched once from San UK's VR for loss severity.
RATING SENSITIVITIES
IDRs, VRs AND SENIOR DEBT
The Long-term IDRs of SGH and San UK could be upgraded to 'A+' as earnings become more diversified through expansion of the retail, commercial and larger corporate franchises and management demonstrates a sustained track record of low risk appetite as it expands the franchise. Given the high indebtedness of UK households, the strong focus of the bank on the UK mortgage lending market, and the lack of geographical diversification, there is limited potential for an upgrade of the VR to the 'aa' category.
San UK's IDR could be upgraded one notch above its VR if debt issued by SGH and subordinated debt issued by San UK and other group entities provide greater protection for senior creditors of San UK. We expect that debt issued by SGH would have to be downstreamed in a way to subordinate it to San UK's external senior creditors to effectively protect them. We believe that the build-up of this debt buffer will not be completed in the short term, and therefore it is not currently reflected in the Positive Outlook.
Negative pressure on San UK's VR, and hence its IDRs, would arise if the bank increased its risk appetite, for example, by more aggressive expansion into commercial lending, or its capitalisation and/or asset quality weakened materially, none of which we expect.
Fitch continues to believe that San UK's reputation and business flows are to some extent correlated with the overall creditworthiness of its parent Banco Santander and that consequently there should be a maximum difference of two notches between the VR of SGH and the Long-term IDR of Banco Santander. San UK's ratings are therefore also sensitive to its parent's IDR.
SUPPORT RATING
San UK's and SGH's Support Ratings are sensitive to a change in the strategic importance of the UK banking group to its parent, which is currently not envisaged, and to Banco Santander's ability to provide support.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings are primarily sensitive to changes in SGH's or San UK's VR. The securities' ratings are also sensitive to a change in their notching, which could arise if Fitch changes its assessment of the probability of their non-performance relative to the risk captured in the issuers' VRs. This may reflect a change in capital management in the group or an unexpected shift in regulatory buffer requirements, for example.
HOLDING COMPANY
SGH's ratings are sensitive to changes in San UK's VR. SGH's ratings are also sensitive to an increase in holding company double leverage, which would result in pressure on ratings.
SUBSIDIARY COMPANIES - ABBEY NATIONAL TREASURY SERVICES (ANTS)
ANTS' ratings are sensitive to changes in San UK's IDRs as well as to the guarantee which is in place on its obligations from San UK.
The full list of rating actions is as follows:
Santander UK Group Holdings plc
Long-term IDR: affirmed at 'A'; Outlook revised to Positive from Stable
Short-term IDR: affirmed at 'F1'
Viability Rating: affirmed at 'a'
Support Rating: affirmed at '2'
Subordinated notes; Fixed Rate Reset Perpetual Additional Tier 1 Capital Securities: affirmed at 'BB+'
Santander UK plc
Long-term IDR: affirmed at 'A'; Outlook revised to Positive from Stable
Short-term IDR: affirmed at 'F1'
Viability Rating: affirmed at 'a'
Support Rating: affirmed at '2'
Senior unsecured debt long-term rating, including programme rating: affirmed at 'A'
Senior unsecured debt short-term rating, including programme rating and commercial paper: affirmed at 'F1'
Market-linked senior unsecured securities: affirmed at 'Aemr'
Subordinated debt: affirmed at 'A-'
Upper Tier 2 subordinated debt: affirmed at 'BBB'
GBP300m Non-cumulative, callable preference shares, XS0502105454: affirmed at 'BB+'
Other Preferred stock: affirmed at 'BBB-'
Abbey National Treasury Services plc
Long-term IDR: affirmed at 'A'; Outlook revised to Positive from Stable
Short-term IDR: affirmed at 'F1'
Senior unsecured debt long-term rating, including programme ratings: affirmed at 'A'
Senior unsecured debt short-term rating, including programme ratings and commercial paper: affirmed at 'F1'
Abbey National Capital Trust 1
USD1bn Trust Preferred Securities (ISIN: US002927AA95) (guaranteed by San UK): affirmed at 'BBB-'
Abbey National North America LLC
Commercial paper: affirmed at 'F1'
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