DBRS Confirms HBOS plc & Related Entities at AA, R-1(middle)

Dominion Bond Rating Service (“DBRS”) has confirmed the ratings of HBOS plc and related entities (collectively, “HBOS” or the “Group”) at the current levels, reflecting the Group’s substantial position in the U.K. retail financial services market, a loan portfolio heavily weighted to less risky residential mortgages, and remarkable progress in extracting cost and revenue synergies from the 2001 merger of Halifax plc and Bank of Scotland. Return on equity is approaching the Group’s targeted sustainable range of 19%-20% and profit growth is commendable at 23% in 2004, and 13% (year-over-year) in H1 2005.

The Group’s unique “consumer champion” marketing and cross-selling strategies have paid off in strong asset growth over the past three years as the Group continues to approach its market share targets of 15% 20% in major retail product categories. Cost/income ratios have improved over the past several years as revenues have increased much faster than expenses. Margin pressures have been modest, related primarily to the cost of wholesale funding in the retail business.

Adjusting for one-time events and investment spending on franchise development in treasury and international banking, all business segments are contributing proportionately. Retail started to fade in H1 2005, but only relatively, as loan growth has slowed and non-performing loans have increased, despite continued progress on cost containment. Increased arrears reflect the natural seasoning of recent growth in specialized mortgage loans and unsecured personal loans, and do not threaten the rating at this time, especially given the Group’s earning power.

HBOS has used its scale to reduce its cost base while focusing on relatively simple, value-for-money products. This strategy has created a “virtuous circle” of activity to date successfully supported the Group’s growth and profit targets.

From a rating perspective, the primary uncertainty is the strategic path HBOS might take as it confronts the limits to organic growth and cost-efficiencies.