DBRS Confirms Lloyds Banking Group plc Ratings at A (high), Trend Negative

DBRS has today confirmed its ratings of Lloyds Banking Group plc (Lloyds or the Group) and related entities, including the Group’s Issuer and Long-Term Debt Rating of A (high). Concurrently, DBRS has confirmed the AA (low) rating of Lloyds TSB Bank plc. The trend on all long-term debt, with the exception the debt guaranteed by HM Treasury, remains Negative. The trend on all Short-Term Debt ratings and the HM Treasury guaranteed debt remains Stable.

Today’s rating action follows Lloyds’ release of its interim results through 30 June 2009. The ratings confirmation reflect the overall strength of the Lloyds franchise, including its Lloyds TSB Bank, Halifax and Bank of Scotland plc brands, and their combined leading market share in key U.K. financial services markets. Moreover, the rating confirmation considers Lloyds’ solid capitalization, improving liquidity profile, and historically sound risk management.

Further, the rating confirmation reflects DBRS’ view that Lloyds’ continues to exhibit solid income generation ability, which, is illustrated by the solid revenue generated during the first half of 2009. During the half year, the Group generated GBP 6.2 billion of trading surplus, representing an increase of 17%. DBRS views this trading surplus as an illustration of the resiliency of the Group’s underlying earnings generation ability and further evidence of Lloyds’ strong franchise, both of which are key factors underpinning the rating. Notwithstanding, the Group reported a loss before tax for H1 2009 of GBP 4.0 billion, largely driven by sizeable impairment charges of GBP 13.4 billion. This was partially offset by a GBP 3.7 billion fair value unwind related to HBOS plc (HBOS) acquisition balance sheet adjustments.

DBRS considers the traditional conservative risk culture at Lloyds TSB as a fundamental strength of the Group which also supports the rating. This conservative credit culture is further demonstrated through the breakdown of the impairment charges, as approximately 80% of the half year’s impairments were related to the legacy HBOS loan book. Although DBRS believes that Lloyds has the ability to manage this credit risk, managing elevated credit costs, most notably within the HBOS legacy portfolio will remain a challenge. This is further exacerbated by the difficult economic environment in the U.K.

The Group’s capitalisation ratios remain acceptable, especially given the balance sheet risk and the pending Government Asset Protection Scheme (GAPS). At 30 June 2009, Lloyds’ core Tier 1 capital ratio was 6.3%, its Tier 1 capital stood at 8.6%, while its total capital ratio was 10.6%. Capital ratios benefited from the GBP 4.0 billion Placing and Compensatory Open Offer completed during the half year and a 3% decline in risk weighted-assets to GBP 482.5 billion. DBRS anticipates that Lloyds’ capital position will strengthen further given the Group’s decision to participate in the GAPS, which will de-risk the balance sheet as risk-weighted assets are reduced and through the Government’s GBP 15.0 billion purchase of Lloyds’ B shares.

The Group’s liquidity and funding remain sound. Lloyds’ leading market share in the U.K. retail deposit market anchors its sound liquidity profile providing Lloyds with a robust and stable funding base. At the half year ending 30 June 2009, retail customer deposits increased 1% to GBP 218.5 billion. Wholesale funding remained well diversified by both type and maturity. Moreover, the Group has lengthened its wholesale funding with 47% of wholesale funding maturing in greater than one year. Further, the Group continues to benefit from actions taken by HM Treasury, including various liquidity facilities, as well as HM Treasury’s guarantee scheme for certain debt issuances.

The trend remains Negative, reflecting DBRS’ view that, while there are early indications of a degree of stabilization in the U.K. economy and housing prices, the operating environment in the U.K. will likely remain challenging. Unemployment is expected to remain elevated which will result in continued pressure on U.K. households, thereby impacting credit costs. Moreover, lower economic activity will lead to subdued loan demand, adding pressure to revenues. Further, deposit margins and net interest margins will likely remain pressured owed to the overall competitive environment and the expectation of an extended period of low base rates. Lastly, DBRS sees ongoing integration challenges with the HBOS acquisition. While in the medium to long-term, DBRS believes that the Group will ultimately benefit from the HBOS acquisition, the near-term headwinds are significant. While the trend remains Negative, DBRS continues to look for indications of a sustained improvement in the operating environment, which, in conjunction with improved financial performance, may lead to a revision of trend to Stable. Progress in achieving a level of profitability is essential for rating stability.

Note:
All figures are in GBP unless otherwise noted.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.