Fitch affirms ratings of eight UK building societies

Fitch Ratings has affirmed the long-term issuer default ratings of eight UK building societies.

It has affirmed the ratings of Coventry Building Society, Leeds Building Society, Newcastle Building Society, Norwich & Peterborough Building Society, Principality Building Society, Skipton Building Society, West Bromwich Building Society and Yorkshire Building Society.

The outlook is negative at Newcastle and West Bromwich and has been revised to negative from stable at Norwich & Peterborough. All other outlooks are stable.

The rating action has no implications for any rated covered bonds issued by any of the societies.

The rating action reflects the stabilisation of the housing and employment markets that has taken place in 2010, the tighter cost control by the societies, their more stable funding bases, and better management of and prospects for their commercial real estate exposure.

However, higher funding and liquidity costs have eroded revenues at many societies and the risk of worse unemployment and weaker house prices remains, which could weigh on profitability.

After a difficult spell in 2009, the societies have all shown themselves able to obtain adequate levels of customer funding. Residential mortgage arrears have declined and despite some challenges, in most cases the societies look better placed to report better, albeit still depressed profits.

Matthew Taylor, senior director in Fitch’s financial institutions team, says: “Future challenges are likely to stem from a possible worsening in residential mortgage arrears, some concentration in commercial real estate lending, subdued revenues, constrained access to wholesale funding and the absence of access to fresh capital.

“However, most of the societies are facing these challenges from a stronger position than a year ago and should be able to meet them at their current rating levels.”

Fitch has downgraded the Support Ratings of the societies, reflecting the agency’s revised view that support from the authorities for their wholesale senior unsecured debt, while possible, cannot be relied upon.

The introduction of the UK Banking Act in 2009 gave the authorities more flexibility in resolving serious problems in a financial institution, which could include different treatment of wholesale senior unsecured debt relative to other liabilities, for example. Wholesale senior unsecured debt in societies forms a relatively small portion of balance sheet footings.

The ratings of member deposits are no longer considered by Fitch to be relevant to the agency’s coverage and have been affirmed and withdrawn.

The ratings of Newcastle reflect its low operating profitability and small absolute size of capital. They also factor in its good liquidity and funding and also generally sound asset quality. Concentrations in its commercial real estate portfolio could amplify the effect on capital of any deterioration in asset quality.

Fitch acknowledges that a significant part of the commercial real estate book is extended to housing associations, which the agency considers low risk. In addition to its traditional products, Newcastle also generates revenues from its services businesses, which Fitch expects should make a positive contribution to group profits in the short to medium term.

Similarly, Newcastle’s repositioning programme, announced in May 2010, is expected to yield a positive impact on costs when fully implemented. Its small operating profits and absolute size of capital make it especially sensitive to single large exposures, which drives the negative outlook.

The ratings of Norwich & Peterborough reflect its moderate exposure to credit risk, its good risk management systems, strong capitalisation, as well as its small size. The Negative Outlook reflects the challenges the society faces in generating reasonable levels of earnings in the short to medium term. N&P’s net interest income is under significant pressure in the low interest rate environment.

Since net interest income is the main earnings driver, Fitch believes N&P will report minimal operating profit in the short to medium term.

There is some uncertainty surrounding the size of a one-off cost related to Keydata Investment Services Limited investment products sold by N&P’s financial advisers. LICs continued to be relatively modest in H110, but larger LICs arising from the weaker economy would weigh on the society’s small pre-LIC operating performance. Following outflows of wholesale deposits, the funding strategy is to maintain around the current level of wholesale funding and focus on reducing the cost of its retail funding.

The ratings of West Bromwich reflect its exposure to commercial real estate and pressure on its NIM. They also factor in its sound funding and liquidity position. Costs have been addressed, which has mitigated the reduction in net interest income.

The agency considers WBBS’s continued focus on reducing its exposure to high risk areas, such as commercial mortgages, and its reduced reliance on wholesale funding as positive.