September 7, 2017 / 5:19 PM / 3 months ago

Fitch Affirms Virgin Money at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) LONDON, September 07 (Fitch) Fitch Ratings has affirmed Virgin Money plc's (VM) Long-Term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook. Fitch has also affirmed VM's Viability Rating (VR) at 'bbb+'. In addition, Fitch has assigned a 'BBB+(dcr)' Derivative Counterparty Rating (DCR) to Virgin Money plc as part of its roll-out of DCRs to significant derivative counterparties in western Europe and the US. DCRs are issuer ratings and express Fitch's view of banks' relative vulnerability to default under derivative contracts with third-party, non-government counterparties. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS IDRS, VR AND SENIOR DEBT The IDRs of VM are driven by its standalone strength, as expressed by its VR and reflect the bank's low risk profile, healthy asset quality, improving profitability, as well as adequate liquidity and capitalisation in relation to its risk profile. Loan growth has been faster than the market average in recent years as the bank has concentrated on developing its franchise through gaining market share and growing its residential mortgage portfolio. Its mortgage loans consist of high quality, low-risk, owner-occupied and buy-to-let (BTL) loans, which are generally extended at moderate loan-to-value ratios (LTVs). It has achieved some diversification by growing its credit card portfolio, partly ahead of schedule. However, the bank's diversification remains limited and largely based on retail lending. Assets are predominantly made up of mortgages and these continue to perform well, supported by a benign economic environment over the past three years with falling unemployment and prolonged low base rates. Arrears and impairment charges are low, average indexed LTVs have been supported by rising house price inflation and the loan book is highly fragmented with generally low average loan sizes. Asset quality remains vulnerable to the high indebtedness of UK households, but in Fitch's opinion, this risk is somewhat mitigated by the sound performance of the UK's mortgage market with low base rates supporting affordability. The bank's credit card portfolio, although higher-risk in nature, is also performing well. Asset quality could also weaken in case of a worsening of the outlook for the UK operating environment, although the bank's resilience to such a development is supported by a focus on low LTVs and strong underwriting standards as well as ongoing low base rates. VM's profitability has strengthened in recent years but relies on net interest income generated from its low-risk mortgage book. Business volumes continued to increase strongly over 1H17, partly compensating the pressure on loan margins generated by the strong supply of credit for better quality mortgage loans. We expect that further improvements in profitability will largely depend on the bank's ability to continue to grow over the next few years. Profitability also benefits from falling funding costs, a changing loan mix and higher-margin credit card exposures. The improvement to the bank's cost-to-income ratio in 1H17 was due to growth in net interest income but we believe costs are also being effectively managed. Given its exposure to low-risk mortgages, VM reports strong regulatory capital ratios based on low risk-weighted assets (RWA), despite these ratios falling gradually in line with the bank's expansion. The bank's common equity Tier 1 (CET1) ratio was 16.3% at end-1H17, with RWA for the bank's residential mortgage portfolio calculated on an internal ratings-based approach. Its end-1H17 leverage was adequate at 4% but will likely be under pressure, at least in the short- to medium-term, as the focus is now likely to be on mortgages, which have low-risk weightings. We expect regulatory capital ratios to be managed down, albeit at levels still comfortably above regulatory requirements. VM is predominantly funded by retail deposits, particularly in the form of savings. It has achieved some diversification of its funding base through accessing wholesale markets, mostly secured, through RMBS issuance as well as participation in the Bank of England's Funding for Lending and Term Funding Schemes. However, management has stated it will manage its wholesale funding appetite conservatively and remain mainly retail deposit-funded. Balance sheet encumbrance has risen to levels that are higher than generally seen at UK banks although we view liquidity as sound and maintained well above regulatory requirements. We have assigned a DCR to VM as it is a counterparty to Fitch-rated RMBS transactions. The DCR is at the same level as the Long-Term IDR because under UK legislation, derivative counterparties have no preferential status over other senior obligations in a resolution scenario. SUPPORT RATING AND SUPPORT RATING FLOOR VM's SR and SRF reflect Fitch's view that senior creditors cannot rely on extraordinary support from the UK authorities in the event the group becomes non-viable given its low systemic importance. 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 the bank. RATING SENSITIVITIES IDRS, VR AND SENIOR DEBT VM's VR and IDRs are primarily sensitive to structural deterioration in profitability, through tighter margins and higher loan impairment charges, and weaker asset quality. This could be caused by a material weakening of the operating environment in the UK if the economic effect of the UK's decision to leave the EU is particularly severe. VM's IDRs, VR, DCR and senior debt ratings are also sensitive to an increase in the bank's risk appetite, which could result in either significantly higher leverage or higher regulatory requirements than at present. Downward pressure on the ratings could also occur should on-balance sheet liquidity buffers reduce or if the funding model becomes less stable. Further diversification of the bank's businesses and continued improvements in its profitability could result in upward pressure on its ratings over the longer term. Any upgrade would be dependent on the bank maintaining its currently moderate risk appetite and sound funding and liquidity. SUPPORT RATING AND SUPPORT RATING FLOOR An upgrade of the SR and upward revision of the SRF would be contingent on a positive change in the sovereign's propensity to support its banks. While not impossible, this is highly unlikely, in Fitch's view. The rating actions are as follows: Long-Term IDR affirmed at 'BBB+'; Outlook Stable Short-Term IDR affirmed at 'F2' Derivative Counterparty Rating: assigned at 'BBB+(dcr)' Viability Rating affirmed at 'bbb+' Support Rating affirmed at '5' Support Rating Floor affirmed at 'No Floor' GBP3 billion senior unsecured GMTN programme: affirmed at 'BBB+' GBP300 million senior unsecured debt, XS1222597731, affirmed at 'BBB+' Contact: Primary Analyst Krista Davies Director +44 20 3530 1579 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Aabid Hanif Associate Director +44 20 3530 1786 Committee Chairperson Redmond Ramsdale Senior Director +44 20 3530 1836 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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