DBRS Confirms Lloyds Banking Group at A; Trend Stable

DBRS Ratings Limited (DBRS) has today confirmed the ratings of Lloyds Banking Group plc (Lloyds or the Group) including the ‘A’ Issuer and Long-Term Debt ratings. The ratings of Lloyds Bank plc are also confirmed at A (high) for the Senior Debt and Deposit rating and R-1 (middle) for the Short-Term Debt rating. The Trend on all ratings is Stable. The Intrinsic Assessment (IA) for Lloyds Bank plc is A (high), while the support assessment remains SA3. As a result, the Bank’s final ratings are positioned in line with the IA.

The confirmation of the ratings reflects the strength of the Group’s domestic retail and commercial banking franchise, which is underpinned by its key market presence in UK mortgages, current accounts, consumer and SME lending, as well as its leading insurance franchise. The ratings also incorporate the Group’s gradually improving statutory profitability, ongoing focus on cost-efficiency, strong capital position, well-positioned funding and liquidity profile and solid credit quality, which has benefited from the successful deleveraging of non-core/run-off assets. At the same time, DBRS expects the Group’s profitability to be pressured by low interest rates as well as the potentially negative impact of Brexit.

The Group’s profitability has been weighed down in recent years by legacy issues, most notably in the form of conduct provisions, such as Payment Protection Insurance (PPI). DBRS, however, notes that Lloyds is gradually moving closer towards closing the gap between statutory and underlying profits as legacy issues have been reduced. In 1H16 the difference between statutory and underlying profit before tax (PBT) decreased 46% year-on-year (YoY) as the Group booked no additional PPI charges, and conduct provisions decreased 75% YoY, to GBP 460 million. Although the proposed deadline for PPI mis-selling compensation claims has recently been pushed back a year by the Financial Conduct Authority (FCA) to June 2019, and further charges are still possible, DBRS expects the impact of these legacy issues to continue to decline considerably.

DBRS views Lloyds’s risk profile as conservative, benefitting from continued progress in deleveraging non-core/run-off assets, and improved credit quality. In 1H16, Lloyds reported a further improvement in asset quality with the Non-Performing loan ratio declining to 2.0% at end-1H16 (compared to 6.3% at end-2013) and the impairment charge remained low at 0.11% of average advances. The Group’s reduction in its run-off portfolio to GBP 12.2 billion at end-1H16 (from GBP 33 billion at end-2013) has also contributed to strengthening its risk profile and capital ratios. Lloyds has also made ongoing improvements to its funding profile, with further growth in customer deposits and non-core/run-off asset deleveraging helping to reduce the Group’s loan to deposit to 107% at end-1H16.

DBRS notes that the vote in favour of the United Kingdom leaving the European Union (Brexit) on 23 June 2016 is likely to have a negative impact on the large UK banks. For Lloyds this impact is most likely to be realised through a deterioration in macroeconomic conditions. DBRS does, however, positively note that the Group’s UK mortgage exposure, which accounts for 65% of total customer loans and advances at end-1H16, appears well positioned. Average LTVs in the mainstream book (which makes up 75% of the total mortgage book) were 41% in 1H16 (43.3% in 1H15), whilst average LTVs in the buy-to-let (BTL) book (which totalled GBP 54.9 billion at end-1H16) were 52.7% (56.7% in 1H15). DBRS also notes that, whilst still sizeable, the Group has reduced its exposure to the UK Commercial Real Estate sector, which now stands at GBP 19.8 billion at end-1H16. For further information on DBRS’s view on Brexit, please see: DBRS: Brexit Negative for Large UK Banks.

DBRS views Lloyds as having strong capitalisation. With total capital, on a transitional basis, of GBP 48.7 billion at end-1H16, equivalent to 21.8% of risk-weighted assets, Lloyds is well positioned for future regulatory requirements on loss absorbing capacity. At end-1H16, Lloyds also reported a strong fully-loaded CRDIV Common Equity Tier 1 (CET1) ratio of 13.0%, an increase of 20 basis points (bps) from end-2015, and a fully-loaded Basel 3 leverage ratio of 4.7%, leaving the Group well-placed relative to peers.

Concurrently, DBRS has withdrawn the ratings of LBG Capital No. 1 and LBG Capital No. 2 following the redemption of all Enhanced Capital Notes in March 2016.

RATING DRIVERS

Positive rating pressure could result from Lloyds demonstrating a longer track record in generating strong, stable net earnings, in addition to delivering continued success in executing its strategy, specifically with regards efficiency savings.

Negative rating pressure could result from a failure to maintain an acceptable level of consistent profitability or if the Group were to significantly increase its risk profile.

Notes:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2016). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (March 2016), Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016) and Critical Obligations Rating Criteria (February 2016). These can be found can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include company documents, the European Banking Authority, the Prudential Regulatory Authority and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating to be 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 historical default rates published by the European Securities and Markets Authority (“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: February 4, 2016

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