DBRS Upgrades Lloyds Bank’s Long-Term Issuer Rating to AA (low), Stable Trend

DBRS Ratings Limited (DBRS) upgraded the Long-Term Issuer Ratings of Lloyds Banking Group plc (Lloyds or the Group) and its related entities. The Group’s Long-Term Issuer Rating was upgraded to A (high) and Lloyds Bank plc’s (the Bank) Long-Term Issuer Rating was upgraded to AA (low). The Bank’s R-1 (middle) Short-Term Issuer Rating and the Group’s R-1 (low) Short-Term Issuer Rating were both confirmed. The trend on all ratings is Stable. The Intrinsic Assessment (IA) for the Bank is now AA (low) and the Support Assessment of the Group remains SA3. Concurrently, DBRS discontinued several ratings for business reasons and renamed the “Mandatory Pay Subordinated Debt” rating as “Subordinated Debt”, in line with DBRS’ standard nomenclature. Please see a full list of the rating actions at the end of this press release.

KEY RATING CONSIDERATIONS
The upgrade of the Long-Term Issuer Rating reflects the continued improvement in Lloyds’ statutory profitability, driven by the consistent reduction of charges related to legacy issues. DBRS expects a further improvement in the Group’s statutory profitability as the drag from Payment protection insurance (PPI) and other conduct provisions should reduce further in the near to medium term. DBRS also takes into account the build-up of loss-absorbing capacity, evident in the strengthening of the MREL ratio over the last year.

The Bank’s IA of AA (low) reflects the strength of the Group’s domestic franchise which incorporates its leading market shares across a wide variety of retail and SME business lines in the United Kingdom (UK), including residential mortgages, consumer and SME lending, current accounts and life insurance. Underlying earnings are strong, supported by the focus on profitable core activities and the strong cost efficiency. The IA also incorporates the conservative risk profile, and the solid funding and liquidity profile. The Group’s capital ratios are robust, supported by very strong underlying internal generation, and compare well with many domestic and international peers.

RATING DRIVERS
Given the recent rating action, further upward pressure is unlikely in the short-to-medium term. However, a track record of consistently strong statutory earnings, combined with maintenance of low risk profile and solid capital could result in positive rating pressure.

Negative pressure could arise from a material deterioration in asset quality or a higher than expected drag from litigation and conduct, leading to a significant weakening of capital. A substantial negative impact of the UK’s exit from the EU on the Group’s risk profile could also exert downward pressure on the ratings.

RATING RATIONALE
Lloyds is one of the largest UK banking groups, with total assets of GBP 818 billion at end-1Q19. The Group has a powerful market share in UK retail and commercial banking and a strong position in life insurance. In February 2018, Lloyds announced a new strategic plan for the 2018-2020 period, focused on transforming the Group into a digitised, low risk UK financial services provider, leveraging its multi-brand model. In the first year of the plan Lloyds made good progress against its strategic targets.

The Group’s underlying earnings generation capacity remains strong, supported by the significant domestic franchise, as well as market leading cost efficiency. The Group’s statutory profitability has been weighed down in previous years by legacy issues, however there has been a consistent reduction of the drag from legacy conduct issues and DBRS expects the gap between underlying and statutory performance to continue to narrow in the near to medium term. In FY18 statutory pre-tax profit was GBP 6.0 billion, up 13% on FY17, driven by an improvement in the underlying performance and a significant decline in PPI provisions. Underlying profit was GBP 8.1 billion, up 6% year-on-year (YoY) driven by higher net income and lower total costs, partly offset by higher impairment charges. The Group’s cost efficiency indicators compare favourably with those of many European and domestic peers. In FY18 the underlying cost-income ratio was 49.3% and 46.0% after excluding remediation costs and both measures improved YoY. Earnings remained strong in 1Q19 with statutory profit before tax of GBP 1.6 billion, flat YoY as a solid improvement in underlying earnings was offset by a more negative balance of volatility and other items, which included an estimated charge for exiting the Standard Life Aberdeen investment management agreement.

Lloyds’ risk profile is conservative, supported by cautious underwriting and focus on domestic mortgage lending. Following a rapid improvement between 2012 and 2015, more recently the share of impaired loans has begun to stabilise at relatively low levels. At end-FY18, Stage 3 exposures under IFRS 9 (assets, which have defaulted or are otherwise considered to be credit impaired) accounted for 1.9% of gross loans and advances on an underlying basis, flat compared to the January 1, 2018 level. The Group’s cost of risk (Asset Quality Ratio - AQR - as defined by Lloyds) was a low 25bps in 1Q19, increasing moderately compared to 21 bps in 2018 and 18bps in 2017, due to lower provisions releases and write-backs. DBRS notes that UK’s departure from the EU could potentially lead to a deterioration in UK macroeconomic conditions. However, DBRS would expect its impact to be mitigated by the Group’s conservative underwriting standards and a low risk mortgage book.

The Group has suffered a significant financial and reputational impact from conduct risk issues. During 2018, Lloyds added GBP 750 million to PPI provisions to reflect the higher than expected complaint volumes. Remediation charges, which include other conduct provisions, totalled GBP 600 million in FY18. Both the PPI provisions and remediation charges declined YoY. In 1Q19 the Group booked an additional GBP 100 million for PPI and GBP 20 million for remediation costs. DBRS expects the drag from legacy conduct issues to continue to decline.

Lloyds’ funding position remains strong, benefiting from a leading position in UK current accounts and savings and access to a range of funding markets. Customer deposits, excluding repos, were GBP 416 billion at end-FY18, covering almost 70% of the Group’s funding requirement. The loan-to-deposit ratio was 107%, flat compared to the 1st January 2018 level. The Group maintains a solid liquidity profile, with a liquidity portfolio of GBP 129 billion at end-FY18, equivalent to over three times the outstanding short-term wholesale funding (excluding derivative collateral margins and settlement) and over five times the money market funding. The Group comfortably meets the Liquidity Coverage Ratio (LCR) requirements, with a ratio of 130% at end-FY18.

DBRS views Lloyds as having a strong capital profile, comparing favourably with many domestic and international peers. In its view of capital, DBRS takes into account the Group’s very strong underlying capital generation capacity. At end-1Q19 the Common Equity Tier 1 (CET1) ratio on a pro forma basis (including reflecting the Insurance dividend received in February 2019, ordinary dividends paid and the share buyback) was 13.9%. DBRS notes that in early 2019 Lloyds announced an updated capital guidance, following the PRA’s notification of the Systemic Risk Buffer for the Ring Fenced Bank and the Group as well as a 30 basis point reduction in the Group’s Pillar 2A requirement, announced in July 2018. The new CET1 capital guidance is 12.5%, plus a management buffer of circa 1% (previously 13% plus 1% management buffer). The fully loaded UK leverage ratio was a strong 5.5%, while on a CRD IV basis the leverage ratio was 5.1%. The end-2018 transitional total capital ratio and the transitional pro forma MREL ratio were a strong 22.9% and 32.4%, respectively.

The Grid Summary Grades for Lloyds Bank plc are as follows: Franchise Strength – Very Strong/Strong; Earnings – Strong; Risk Profile – Strong; Funding & Liquidity – Strong; Capitalisation – Strong.

Notes:
All figures are in GBP unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018). This can be found can be found at: http://www.dbrs.com/about/methodologies.

The sources of information used for this rating include SNL Financial, the Bank of England, European Banking Authority and company documents. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating did not include participation by the rated entity or any related third party and is based solely on publicly available information.

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 and US regulations only.

Lead Analyst: Tomasz Walkowicz, Vice President, Global Financial Institutions
Rating Committee Chair: Ross Abercromby, Managing Director, Global Financial Institutions
Initial Rating Date: January 19, 2009
Last Rating Date: June 8, 2018

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