DBRS Confirms Lloyds Banking Group at A (high), Trend Revised to Stable

DBRS Ratings Limited (DBRS) has today confirmed the ratings of Lloyds Banking Group plc (Lloyds or the Group) including the A (high) Issuer and Long-Term debt ratings. The ratings of Lloyds Bank plc are also confirmed at AA (low) for the Senior debt and deposit rating and R-1 (middle) for the Short-term rating. The Trend on all long-term ratings has been revised to Stable from Negative while the Trend on the Short-term rating remains Stable. The Intrinsic Assessment (IA) for Lloyds Bank plc is A (high). DBRS views the Group as systemically important within the U.K. and therefore maintains its Support Assessment at SA-2. This reflects DBRS’s expectation that some form of timely systemic support would be provided to the Group, if needed, and leads to a one-notch uplift of the final rating from the IA.

In revising the trend to Stable, DBRS recognises the significant progress that Lloyds has continued to make over the past 18 months in the restructuring of the Group, and notes that this is now in its final stages. Over this period, Lloyds has also demonstrated further improvements in asset quality, costs, funding and capital. In addition, the UK Government has been able to reduce its shareholding to 24.9% and the Group has now sold a 38.5% stake in TSB, the first step in the EU mandated sale of this business. DBRS notes that the Group’s net profitability continues to be affected by legacy and one-off items, but expects the impact of these to decline considerably in coming periods.

In 1H14, Lloyds reported a further improvement in asset quality with the Non-Performing loan ratio declining to 5% at end-June 2014 (compared to 8.6% at end-2012) and the impairment charge falling to 0.3% of average advances (1.0% in 2012). The Group’s reduction in its run-off portfolio to GBP 25 billion at end-June (from GBP 33 billion at end-2013) has also contributed to strengthening its risk profile and capital ratios. In addition, the Group improved its loan-to-deposit ratio to 109% at end-June 2014, as it continues to grow deposits. And the Group’s underlying profitability has been helped by an increase in the Banking Net Interest Margin to 2.48% in 2Q14 from 2.06% in 2Q13. Moreover, DBRS expects Lloyds to benefit from the current recovery in the UK economy and any gradual increases in interest rates in the UK.

However, Lloyds’ statutory profit before tax (GBP 863 million in 1H14) has still been hampered by a number of legacy issues, including Payment Protection Insurance (PPI) provisions (totalling GBP 10.425 billion over 2011 – 1H14), as well as restructuring costs and other one-off issues. On an underlying basis, Lloyds reported pre-tax profit of GBP 3.8 billion in 1H14, and DBRS expects the Group’s statutory profit to be much closer to its underlying profit in coming periods. As an example, Lloyds has already taken GBP 2.21 billion of the planned GBP 2.4 billion Simplification Programme costs, and although UK banks have struggled to accurately forecast PPI charges, there continues to be a gradual reduction in claims, and Lloyds holds GBP 2.3 billion unutilised provisions for PPI redress.

Although there are still a number of regulatory developments to come – including the Prudential Regulation Authority’s finalisation of capital buffers and leverage ratios, and implementation of ringfencing in the UK, DBRS considers that Lloyds is relatively well positioned to meet these challenges reporting a fully-loaded Common Equity Tier 1 ratio of 11.1% at end-June 2014 and leverage ratio of 4.5%.

The ratings are unlikely to see upward pressure in the medium term, given the already high level of the ratings and the need for Lloyds to demonstrate the ability to deliver strong, stable net earnings. Downward rating pressure could emerge from an unexpected deterioration in the UK housing market with a knock-on effect on the Group’s asset quality.

Notes:
All figures are in Pound Sterling (GBP) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (June 2014). Other applicable methodologies include the DBRS Criteria: Support Assessment for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013).These can be found can be found at: http://www.dbrs.com/about/methodologies

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

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see: http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Elisabeth Rudman
Rating Committee Chair: Roger Lister
Initial Rating Date: January 19, 2009
Most Recent Rating Update: July 15, 2014

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