Fitch affirms UK building societies following peer review
Fitch has affirmed the ratings of five UK building societies following a periodic review. The building societies, Coventry Building Society (A/Stable/F1), Yorkshire Building Society (A-/Stable/F1), Skipton Building Society (A-/Stable/F1), Leeds Building Society (A-/Stable/F1) and Principality Building Society (BBB+/Stable/F2), together accounted for over 10% of gross mortgage lending in the UK in 2016.
The affirmation of the societies’ ratings reflects their overall moderate risk profile, strengthened asset quality, strong capitalisation and solid funding franchises. The ratings also reflect net interest margin pressure on the societies’ earnings and the concentration of their business on the UK housing market.
Despite fast growth at some societies, we believe that underwriting standards are holding up well. Although increased competition, including from challenger banks and non-bank lenders, could over time result in a relaxation of underwriting standards as pressure on margins persists, the five building societies have maintained their risk appetite. UK residential mortgage lending is primarily originated through intermediaries – although all building societies continue to underwrite loans in-house – meaning competition for new mortgage lending is largely based on price.
Lending growth has helped the building societies to mitigate pressure on loan margins, and several building societies are also focusing on improving cost efficiency to strengthen profitability in the medium term. Low funding costs and cyclically low loan impairment charges have also helped support operating profitability. However, we expect net interest margins to decline further in 2017 due to ongoing competitive pressure, and revenue generation will remain a key challenge for the building societies, given their dependence on net interest income as a source of revenue.
Residential mortgage loans continue to perform well in a still benevolent economic environment with low interest and unemployment rates. We believe that asset quality is at a cyclical high and is likely to gradually deteriorate, but expect this to be easily manageable for the building societies given prudent underwriting standards. Asset quality is sensitive to a material weakening of the UK operating environment if the economic environment deteriorates substantially following the UK’s decision to leave the EU.
The UK building societies’ regulatory capital ratios are high compared to most major UK banks and well above regulatory requirements. Strong capital is important for building societies given their mutual structures that provide only limited options to raise additional core capital if necessary. Reported common equity tier 1(CET1) ratios have strengthened as a result of some societies moving to the internal ratings-based (IRB) approach and CET1 ratios may continue to strengthen in the near term, but we believe that the leverage ratio will act as a back-stop to excessive balance sheet growth.