Feb 28 (The following statement was released by the rating agency)
Fitch Ratings has assigned Nationwide Building Society's (A/Stable/F1/a) potential issue of perpetual subordinated contingent convertible securities (the notes) an expected rating of 'BB+ (EXP)'. The final rating is contingent on receipt of final documentation conforming to information already received.
KEY RATING DRIVERS
The notes are additional Tier 1 (AT1) instruments with fully discretionary interest payments and are subject to conversion into Nationwide Core Capital Deferred Shares (CCDS) on breach of a 7% CRD IV common equity Tier 1 (CET1) ratio (either consolidated or solo), which is calculated on a 'fully loaded' basis.
The securities are rated five notches below Nationwide's 'a' Viability Rating (VR), in accordance with Fitch's criteria for "Assessing and Rating Bank Subordinated and Hybrid Securities" (dated 31 January 2014). The notes are notched twice for loss severity to reflect the conversion into CCDS on breach of the trigger, and three times for non-performance risk.
The notching for non-performance risk reflects the instruments' fully discretionary interest payment, which Fitch considers the most easily activated form of loss absorption. The issuer will not make an interest payment if it has insufficient distributable items or if it is insolvent. The issuer will also be subject to restrictions on interest payments if it fails to meet the combined buffer capital requirements that will partly be phased in from 2016.
Nationwide's fully loaded Basel III CET1 consolidated ratio at 31 December 2013 (9M14) was 13.1% (12.8% calculated on a solo basis), including GBP550m CCDS it issued in December 2013. This provides it with a buffer of around GBP2.5bn for the 7% CET1 ratio trigger. However, non-performance in the form of non-payment of interest could be triggered before reaching the 7% CET1 ratio trigger, either by breaching the combined buffer requirement (or possibly though a breach of a minimum leverage ratio). These additional regulatory requirements considerably reduce the buffer.
The combined buffer requirements will partly be phased in at 25% per annum from 1 January 2016 Given our understanding that building societies will likely have to meet similar buffer requirements as ring-fenced banks, the minimum combined buffer requirement applicable from 1 January 2019 for Nationwide will be at least 5.5%. The UK regulator has also clarified that 56% of Pillar 2 requirements should be covered by CET1 capital rather than by total regulatory capital. We estimate therefore that Nationwide will have to maintain a CET1 ratio of at least 10.5%-11.5% by 2019. Under this scenario, the headroom over its buffer reduces to around GBP1.1bn-GBP0.7bn, using estimated end-December 2013 figures.
Nationwide plans and Fitch expects the society's CET1 ratio to strengthen over time to 2019, increasing the headroom it will have over 10.5%-11.5%. While we expect that Nationwide will meet its regulatory capital expectations, additional non-performance risk is introduced by the possibility that the combined buffer requirements for Nationwide could change over time, and additional buffers, for instance in the form of countercyclical buffers, and time adjusted leverage ratio could be phased in earlier than 2016, at the discretion of the UK government.
Fitch has assigned 100% equity credit to the securities. This reflects their full coupon flexibility, the ability to be converted into CCDS, which Fitch considers core capital well before the bank would become non-viable, the permanent nature and the subordination to all senior creditors.
As the securities are notched from Nationwide's VR, their rating is mostly sensitive to any change in this rating. The securities' ratings are also sensitive to any change in their notching, which could arise if Fitch changed its 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.