DBRS Comments on Lloyds Banking Group plc’s 1Q12 Results; Senior Unaffected at A (high), Stable

DBRS, Inc. (DBRS) has today commented that the ratings for Lloyds Banking Group plc (Lloyds or the Group), including its Issuer and Long-Term Debt rating of A (high) and the ratings of Lloyds TSB Bank plc, including its Senior Debt & Deposits rating of AA (low), are unaffected by the Group’s announcement of results for 1Q12. The trend for all ratings is Stable.

Lloyds’ results evidence resilient performance by the core businesses despite the slowing U.K. economic environment. Moreover, the results demonstrate further progress in strengthening the balance sheet, reshaping the business, and removing risk. For 1Q12, Lloyds reported a statutory profit before tax of GBP 288 million compared to a loss before tax of GBP 3.5 billion a year ago. The improved year-on-year (y-o-y) result primarily reflects the absence of a GBP 3.2 billion provision for PPI contact and redress incurred in 1Q11; however, DBRS notes that the Group’s 1Q12 results were impacted by a PPI provision charge of GBP 375 million related to an industry-wide increase in complaints. On an underlying basis, which excludes the impacts of integration, simplification and Project Verde costs, volatility arising in insurance businesses, PPI, amortisation of purchased intangibles, and past service pensions credit, Lloyds’ generated a profit before tax of GBP 628 million compared to a profit before tax of GBP 284 million in 1Q11. The improved results were driven by a substantial decline in credit costs and reduced operating costs partially offset by lower revenues.

Underlying income (revenue) at GBP 4.7 billion was 15% lower year-on-year reflecting reduced demand for lending, customer deleveraging, lower non-core assets, and higher wholesale funding costs. Importantly, the results benefitted from impairments that were lower across all four core segments resulting in a 31% quarter-on-quarter reduction to GBP 1.7 billion. While still elevated at GBP 705 million, Wealth and International, impairment charges declined 47% quarter-on-quarter. Notably, in Ireland, which has been a significant driver of the high credit costs, impairments decreased 26% quarter-on-quarter reflecting moderation in the rate of increase in newly impaired loans and the reduction in non-core assets in Ireland. DBRS views the results, in a challenging operating environment, as illustrating the resiliency of the underlying earnings power of the core businesses and the significant strength of the franchise, both of which are key considerations underpinning the ratings. Further, in DBRS’s view, the results evidence the progress management has made in addressing credit risks while remodelling the business.

Credit performance continues to improve. In Retail the number of new cases moving to arrears has once again declined, extending the positive trend established in 2011. Moreover, in the Wholesale and Commercial segments, the rate of assets becoming impaired has moderated significantly. Indeed, in Wholesale, newly impaired loans totalled GBP 667.3 million in 1Q12, a 69% reduction from the 2011 quarterly average. While in Commercial, newly impaired loans totalled GBP 118.0 million, representing a 38% reduction from the 2011 quarterly average. DBRS views favourably the positive trends in credit metrics as validation of the de-risking actions taken by management, and that Lloyds’ traditional conservative risk culture and prudent lending standards are being exported throughout the Group.

Group-wide net interest margin (NIM) and Core business NIM were resilient with Group-wide NIM declining 2 basis points quarter-on-quarter to 1.95%, while Core business NIM also was 2 bps lower quarter-on-quarter at 2.32%. The modest reduction reflects the benefits of asset pricing and the increased preponderance of deposits in the funding mix, which partly offset higher wholesale funding costs. Lloyds has made good progress in its strategic goal to simplify the Group and reduce costs. Illustrating management’s efforts, total costs were 7% lower y-o-y to GBP 2.6 billion. Nonetheless, the cost-to-income ratio improved modestly, declining 20 bps to 57.1%, owed to the decline in revenues outpacing the reduction in costs.

The Group reports good progress towards reducing balance sheet risk. Non-core assets, at GBP 128.3 billion, were reduced 9% from year-end 2011. Impressively, the Group has achieved approximately 82% of its five year balance sheet reduction plan in the first three years. DBRS notes that of the GBP 1.7 billion of impairment charges in 1Q12, GBP 1.2 billion were attributable to assets in the non-core books.

Lloyds has made more progress in strengthening its funding and liquidity profile. During the quarter, wholesale funding was reduced by 8% to GBP 231 billion. Furthermore, the Group has further extended the maturity profile of its wholesale funding profile, with 60% of wholesale funding having maturities greater than one year as compared to 55% at year-end 2011. Importantly, despite turbulent conditions in the capital markets, Lloyds maintains good market access, as illustrated by the Group’s ability to complete its 2012 wholesale term issuance plan by the end of April 2012. Liquidity is substantial with GBP 106.4 billion of primary liquid assets, which equates to 187% of money market positions. Evidencing the benefits of the increased investment in the core brands and the overall strength of the Lloyds’ franchise, Group-wide deposits, excluding repos, increased 2% in 1Q12 to GBP 412 billion, and now represent 64% of total funding. As a result, the loan-to-deposit ratio improved to 130%, meeting the Group’s 2014 target levels two years early; within the core business the ratio stood at 105% at the end of the first quarter.

Regarding capital, Lloyds bolstered its capitalisation and, in DBRS’s view, is well placed to meet future regulatory requirements. At 31 March 2012, the Group’s core Tier 1 ratio, at 11.0%, increased 20 basis points from year-end 2011. The improved capital position also reflects a 2% reduction in RWAs attributed to the reduction in the non-core asset portfolio, limited demand for new lending, and the improving quality of core lending books.

Notes:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following that disclosure.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Steven Picarillo
Approver: Alan G. Reid
Initial Rating Date: 19 January 2009
Most Recent Rating Update: 14 November 2011

For additional information on this rating, please refer to the linking document under Related Research.