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SANTANDER UK PLC

(SAN)
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Fitch Affirms Santander UK Group Holdings at 'A'/Stable

01/21/2022 | 04:19am EDT

Fitch Ratings has affirmed Santander UK Group Holdings plc's (SGH) Long-Term Issuer Default Rating (IDR) at 'A' with a Stable Outlook.

The IDR is driven by SGH's 'a' Viability Rating (VR).

Fitch has withdrawn SGH's and Santander UK plc's (San UK) '2' Support Ratings (SR) and Santander Financial Services plc's (SFS) '1' SR as they are no longer relevant to Fitch's coverage following the publication of our updated Bank Rating Criteria in November 2021. In line with the updated criteria, Fitch has assigned Shareholder Support Ratings (SSR) of 'bbb+' to SGH and San UK and of 'a' to SFS.

Key Rating Drivers

SGH is the holding company for Banco Santander, S.A.'s (Santander) UK legal entities, consisting of SGH, San UK (the main operating company and core bank) and SFS. SGH's VR is equalised with that of San UK, reflecting SGH's role as a holding company and its low double leverage, which remains below 120%. Fitch does not assign a VR to SFS as we believe SFS's business model and strong reliance on SGH prevent a meaningful standalone analysis of the entity.

SGH's and San UK's 'a' VRs are based on SGH's consolidated financial profile and reflect the group's conservative risk appetite, low impaired loans, adequate capitalisation, and a stable funding and liquidity profile. They also reflect a less-diversified business model than larger UK peers', which weakens the group's earnings.

SGH's business diversification has remained fairly limited, despite plans to increase the contribution of SME and corporate banking. Following the implementation of ring-fencing regulation in the UK (San UK is a ring-fenced bank), the group transferred its remaining corporate & investment banking (CIB) assets to parent Santander's London branch In October 2021. Nevertheless, SGH business profile continues to benefit from a strong franchise in mortgages and retail current accounts, which support a low-risk business model.

SGH's risk appetite is fairly conservative. As a result, loan growth has been lower than peers' as the group has focused on owner-occupied mortgage loans, at low loan-to-value (LTV) ratios. Although the group has some appetite for consumer lending, SGH focuses on auto finance, where it benefits from the security of the underlying vehicle. Buy-to-let mortgages, which SGH views as higher risk, do not account for a large proportion of mortgage loans. We do not expect the group to loosen its underwriting standards significantly to gain market share.

Asset quality is healthy, and the group's 1.35% impaired loans ratio at end-9M21 compares well with peers'. Asset quality has benefited from large government support to borrowers since the start of the pandemic. We do not expect impaired loans to exceed 2% of gross loans in the medium term.

While we view consumer lending as a higher-risk asset class that is more volatile through the cycle, auto finance, which accounts for most of SGH's consumer-finance exposure, has benefited from global new car shortages, which have supported used-car values and therefore the value of the collateral securing these exposures.

Like other UK banking groups, SGH has begun to release some of the large loan loss allowances it raised in 2020, given the more positive outlook for the UK economy. These releases have resulted in operating profit/risk-weighted assets (RWA) recovering strongly to 2.7% in 9M21 from a low of 0.9% in 2020. We expect the four-year average to remain above 1.5% over the next two years and to benefit from improved efficiency over the medium term as a result of the group's ongoing cost-reduction programme. We have therefore upgraded our profitability score to 'a-' from 'bbb+'.

SGH's common equity Tier 1 (CET1) ratio increased to 16.6% at end-9M21 as it benefited from the sale of CIB assets to Santander's London branch and the sale of the group's 50% shareholding in PSA Finance UK Limited, both of which reduced RWAs. It also benefited from a regulatory benefit for intangible software assets that ended on 1 January 2022. It also increased as a result of temporarily suspended dividend payments in 2020 under industry-wide regulatory guidance. However, we expect that the resumption of dividend payments will result in capital ratios falling, given current headroom above management's 5% UK leverage ratio target.

SGH benefits from a large base of low-cost current account deposits, which help the group to maintain acceptable margins on its low-risk loan book. It also benefits from proven independent access to wholesale-funding markets and ordinary support from Santander. Liquidity is prudently managed and benefits from access to the Bank of England's liquidity schemes, if necessary.

San UK's Long-Term IDR is one notch above the bank's VR because the resolution plan for the single-point-of-entry UK resolution group headed by SGH envisages San UK's third-party senior creditors being protected in a bank failure by sufficient qualifying junior debt (QJD) and equity raised by SGH. Fitch calculates a QJD buffer equivalent to 16.4% of RWA at end-9M21 (excluding SGH senior debt that is not eligible for MREL (minimum requirement for eligible liabilities) or has a call date in 2022).

San UK's Derivative Counterparty Rating (DCR) is at the same level as the bank's Long-Term IDR because derivative counterparties have no preferential status over other senior obligations in a resolution under UK legislation. The senior unsecured debt instruments of all entities are rated in line with their respective Long-Term IDRs.

The Short-Term IDRs of 'F1' for SGH and its rated subsidiaries are the lower of two options mapping to the respective Long-Term IDRs, as our assessment of the group's funding and liquidity profile does not warrant a higher Short-Term IDR.

SHAREHOLDER SUPPORT RATINGS (SSR)

We have assigned a 'bbb+' SSR to SGH and San UK based on support from Santander. This is one notch below Santander's Long-Term IDR because we view Santander's ability to provide support as constrained by the UK entities' large size relative to Santander's own equity as well as by possible regulatory restrictions. In our view, Santander has a strong propensity to support both entities, given the strategic importance of the UK as well as the high reputation risk Santander would face in the case of a default by its UK entities.

Rating Sensitivities

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The ratings are primarily sensitive to changes in the VR, which could be downgraded if economic disruptions are worse than our assumptions. A downgrade could be triggered if we expect the Stage 3 loan ratio to increase above 3% without a clear path to reduction.

San UK's senior debt ratings and DCR, which benefit from uplift due to resolution funds, could be downgraded if we no longer expect that the group's resolution planning and requirements afford San UK's senior creditors protection in a group failure.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade of the VR is unlikely within the rating horizon given our current assessment of the key rating drivers. However, over the longer term the ratings could be upgraded if SGH's business model becomes more diversified and comparable to those of higher-rated UK peers, resulting in higher and more sustainable earnings.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

SUBORDINATED DEBT AND HYBRID SECURITIES

The ratings of all subordinated debt and hybrid securities issued by SGH and San UK are notched down from their VRs.

SGH's additional Tier 1 capital securities are rated four notches below the group's VR to reflect above-average loss severity risk (two notches) and higher risk of non-performance as coupon payments are fully discretionary (two notches). Dated lower Tier 2 instruments are notched down twice from the VR for above-average loss severity.

Legacy Tier 1 securities issued by San UK are rated four notches below the bank's VR to reflect higher loss severity risk (two notches) and higher risk of non-performance due to discretionary coupon payments (two notches).

Legacy upper Tier 2 securities are rated three notches below San UK's VR (two for loss severity and one for non-performance). Legacy dated Lower Tier 2 instruments are notched down twice from the VR for loss severity.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The ratings of subordinated debt and hybrid securities are primarily sensitive to changes in the VRs from which they are notched. Additional Tier 1 and other discretionary Tier 1 instruments are also sensitive to Fitch changing its assessment of the probability of their non-performance relative to the risk captured in the VR. This could occur if there is an adverse change in capital management or flexibility, or an unexpected unfavourable shift in regulatory buffers. Tier 2 subordinated debt ratings are also sensitive to an adverse change in Fitch's assessment of loss severity in default.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade of SGH's and San UK's VRs would likely result in an upgrade of the respective entities' subordinated debt and hybrid securities.

SUBSIDIARIES & AFFILIATES: KEY RATING DRIVERS

SFS's IDRs are based on support from SGH. SFS's 'a' SSR is in line with SGH's IDR and reflects SGH's strong propensity to support SFS, given SFS's role in the group, and a strong ability to provide support, given SFS's small size. We uplift SFS's IDR one notch above SGH's IDR because we expect that the group's QJD and equity will protect SFS's third-party senior creditors should the group fail.

SUBSIDIARIES AND AFFILIATES: RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

SFS's ratings are primarily sensitive to changes in SGH's IDRs. They are also sensitive to a reduction in SGH's propensity to support SFS, which we do not expect. A downgrade of SGH's IDRs would likely result in a similar downgrade to SFS's IDRs.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

An upgrade of SGH's IDRs would likely result in a similar upgrade to SFS's IDRs.

VR ADJUSTMENTS

The operating environment score of 'aa-' is at the lower end of the range because it is constrained by the UK sovereign rating of 'AA-'/Stable (negative).

The capitalisation and leverage score of 'a' has been assigned below the implied 'aa' score, due to the following adjustment reason: historical and future metrics (negative).

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

SGH's and San UK's SSRs are driven by our view of Santander's support propensity. SFS's ratings are driven by our view of SGH's support propensity.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

(C) 2022 Electronic News Publishing, source ENP Newswire

Stocks mentioned in the article
ChangeLast1st jan.
BANCO SANTANDER, S.A. -1.04% 2.6995 Delayed Quote.-7.23%
SANTANDER UK PLC 0.09% 163.05 Delayed Quote.-8.35%
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