Fitch Ratings has affirmed Nationwide Building Society's (Nationwide; A/Stable/F1) GBP15bn mortgage covered bonds at 'AAA' with a Stable Outlook following a review of the programme.
KEY RATING DRIVERS
The covered bonds' rating is based on Nationwide's Long-Term Issuer Default Rating (IDR) of 'A' and a Discontinuity Cap (D-Cap) of 4 (moderate risk), which allow for a maximum achievable rating for the covered bonds of 'AA+' on a PD basis, and 'AAA' after factoring in recoveries given default. The rating is also based on the asset percentage (AP) of 84.5% used in the asset coverage test, which is communicated in the investor report, providing a cushion compared with Fitch's breakeven AP of 90% for the 'AAA' rating.
The Outlook on the covered bonds' rating is Stable, driven by the Stable Outlook on Nationwide's IDR.
The D-Cap of 4 is driven by the moderate risk assessment of three out of five components: liquidity gap and systemic risk, systemic alternative management and privileged derivatives components, which are the joint weakest of the D-Cap components. Fitch has assessed the asset segregation and cover pool-specific alternative management components as low risk.
The moderate risk assessment for the liquidity gap and systemic risk reflects Fitch's view of mitigants against liquidity gaps in the form of a three-month interest reserve fund and a 12-month extendible maturity on the covered bonds. The systemic alternative management's assessment reflects the challenges of the administrator post issuer default to perform significant functions and contract other parties in a timely manner. The agency takes comfort from the active oversight taken by the FCA under the UK regulated covered bond framework and the appointment of an alternative manager post issuer default. Finally, the moderate risk assessment for the privileged derivatives is due to the internal asset swap in place on the cover pool, which is considered highly material to the programme.
Nationwide has implemented a new IT system for the cover pool mortgage selection and reporting called ABS Suite. This has been in place since January 2013. Fitch takes comfort from the fact that this system is available on the market and is used by other covered bond issuers and the risk assessment for the cover pool-specific alternative management component of the D-Cap is low.
The 'AAA' breakeven AP has increased to 90% from 88% last year. This supports a 'AA' rating on a PD basis and allows for a two-notch recovery uplift for the covered bonds in a 'AAA' scenario. The increase was driven by lower refinancing stress assumptions reflecting a sustained decrease in UK RMBS spreads over the past 12 months. This results in a lower discounting of the cover assets when modelling a stressed sale of the assets in Fitch's cash-flows model.
The benefits of lower refinancing spread assumptions are partially offset by (i) the increased maturity mismatch between the cover pool assets and the liabilities; and (ii) the decreasing effect of negative carry, which have a negative impact on the breakeven asset percentage. Both the increase in the maturity mismatch and the decrease in the amount of additional collateral (negative carry) are due to a decrease in the WA life on the bonds (6.8 years at end-August 2013).
There are currently 34 soft bullet bonds outstanding. The bonds are issued in euro, sterling, Swedish and Norwegian krone with a total equivalent amount of approximately GBP15bn compared with GBP17bn in 2012. The WA margin on the bonds has decreased to 0.84% from 0.91% and the WA term to maturity decreased to 6.8 years from 8.1 years as a result of the cancellation of two bonds in April 2013. The cover assets yield both floating and fixed rates and an interest rate swap is in place with Nationwide to transform the interest collections from the cover assets into one-month GBP LIBOR plus a blended spread. Several swaps are in place to hedge interest rate and currency mismatches on the bonds.
At end-August 2013, the cover pool consisted of 272,775 loans totalling GBP22.1bn of residential mortgages in the UK. The WA indexed current loan-to-value is 54.1% and the WA seasoning is 95 months. In total, 27.7% of the pool is on interest only repayment, the remaining 72.3 being amortising. The cover pool assets are well-diversified across the UK, with the highest concentrations in Outer Metropolitan (16.03%), followed by London (12.71%) and Outer South East (12.69%). In a 'AAA' scenario, Fitch calculated that the expected loss on the portfolio is 8.7%.
RATING SENSITIVITIES
The rating would be vulnerable to downgrade if any of the following occurred: (i) Nationwide's IDR was downgraded by two notches to 'BBB+' or lower; or (ii) the D-Cap fell by at least two categories to 2 (high risk); or (iii) the AP that Fitch takes into account in its analysis increased above the 'AAA' breakeven AP of 90%.
Given the dynamic nature of the programme, the composition and credit quality of the cover pool may change over time. The Fitch breakeven AP for the covered bond rating will be affected, among others, by the profile of the cover assets relative to outstanding covered bonds, which can change over time, even in the absence of new issuances. Therefore it cannot be assumed to remain stable over time.
Additional information is available at www.fitchratings.com.
Applicable criteria, 'Covered Bonds Rating Criteria', dated 04 September 2013, 'Counterparty Criteria for Structured Finance and Covered Bonds', dated 13 May 2013, 'Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum', dated 13 May 2013, 'Covered Bond Rating Criteria Mortgage Liquidity and Refinance Stress Addendum' dated 3 June 2013, 'EMEA Residential Mortgage Loss Criteria', dated 6 June 2013 and 'EMEA Criteria Addendum United Kingdom' dated 09 August 2012 are available at www.fitchratings.com.
Applicable Criteria and Related Research:
Covered Bonds Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=717321
Counterparty Criteria for Structured Finance and Covered Bonds
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707155
Counterparty Criteria for Structured Finance and Covered Bonds: Derivative Addendum
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=707156
Covered Bonds Rating Criteria Mortgage Liquidity and Refinance Stress Addendum
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709665
EMEA Residential Mortgage Loss Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709915
EMEA Criteria Addendum United Kingdom Mortgage and Cashflow Assumptions
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685433
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=806402
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