DBRS Morningstar Confirms Lloyds Bank’s LT Issuer Rating at AA (low), Trend Revised to Stable

DBRS Ratings Limited (DBRS Morningstar) confirmed 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 confirmed at A (high) and Lloyds Bank plc’s (the Bank) Long-Term Issuer Rating was confirmed at 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 the long-term ratings has been revised to Stable from Negative.

The Intrinsic Assessment (IA) for the Bank remains at AA (low) and the Support Assessment of the Group remains at SA3. Please see a full list of the rating actions at the end of this press release.

KEY RATING CONSIDERATIONS

The revision of the trend to Stable reflects that the impact of the COVID-19 pandemic and the UK’s withdrawal from the European Union have not materially impacted Lloyds’ earnings power which has remained solid and is now benefiting from a higher interest rate environment.

The confirmation of the long-term ratings also reflects the powerful retail and commercial banking franchise in the UK which is characterised by leading market shares across most retail and business segments, including a market share of 19% in retail mortgages, while its underlying profitability is underpinned by profitable core activities, a low risk profile, and strict cost discipline. New mortgage lending in the UK has been robust throughout the pandemic. In addition, Lloyds’ asset quality remains solid, helped by the low unemployment rate in the UK. The ratings also reflect a robust funding and liquidity position boosted by deposit growth, as well as the robust capital levels.

RATING DRIVERS

An upgrade of the Long-Term ratings would require the Group to substantially improve profitability metrics over the medium term, while maintaining a resilient credit profile.

The Long-Term ratings would be downgraded if the Group’s profitability and asset quality metrics experience a material and sustained deterioration.

RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Very Strong/Strong

Lloyds is one of the largest UK banking groups, with total assets of GBP 887 billion at end-2021 and 26 million customers. The Group has a powerful market position in UK retail and commercial banking and is also one of the largest life insurers and pension providers, with strong market shares across the various products, including a market share of 19% in mortgage balances, and this underpins DBRS Morningstar’s ratings for the Group. As part of its Strategy Update, the Group targets higher and more diversified revenues by deepening customer relationships across various retail products and by further strengthening its SME and corporate franchise.

Earnings Combined Building Block (BB) Assessment: Strong/Good

The improvement in profitability in FY21 was mainly driven by loan loss reversals on the significant provisions taken in FY20 due to the COVID-19 pandemic. The Group also continued to experience strong lending growth driven by robust mortgage activity in the UK. Overall, Lloyds reported a solid pre-tax statutory profit of GBP 6.9 billion in FY21, significantly up from GBP 1.2 billion in FY20 and GBP 4.4 billion in FY19. Statutory profits were up to GBP 5.9 billion in FY21 from GBP 1.4 billion in FY19, translating into a return on tangible equity (ROTE) of 13.8%. We also note the Bank of England increased its key rate in response to inflation for the fourth time since December 2021, with base rate now at 1.0% and this is benefiting the Group’s revenues. In Q1 2022, the Group’s net interest income was GBP 2,945 million, up 10% compared to Q1 2021, and also up 2% compared to Q4 2021. Meanwhile, DBRS Morningstar views Lloyds’s efficiency levels as comparing well with its domestic and international peers with a reported cost to income ratio of 56.7% in FY21 (FY20: 55.3%).

Risk Combined Building Block (BB) Assessment: Good

DBRS Morningstar views Lloyds’s risk profile as generally conservative, with the loan book being based on the large domestic mortgage book. The Group's lending operations are predominantly UK-based, with the book weighed towards retail loans, which account for approximately 73% of total loans and advances to customers. Asset quality indicators have remained contained. The Group's share of Stage 3 exposures (assets which have defaulted or are otherwise considered to be credit impaired) was 2.5% at end-Q1 2022, compared to 1.9% at end-FY21 and 1.7%; end-FY20, however, the increase was solely due to CRD IV regulatory requirements which includes changing the definition of default for mortgages from 180 to 90 days. Lloyds’ asset quality could be impacted as a result of the cost of living pressures in the UK, however, we would expect this to be manageable for the Group given the solid profitability levels. DBRS Morningstar also notes that the Russia-Ukraine conflict does not have direct implications for Lloyds as the Group has a clear UK centric business model, albeit any impact on the macroeconomic environment is likely to impact the Group.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong

Lloyds has a robust funding profile, supported by the strong deposit franchise in the UK. The Group's net loan-to-deposit ratio was 94% at end-FY21, compared to 107-110% in previous years. The Group's liquidity is sound with a GBP 140.2 billion portfolio of highly liquid assets at end-FY21 and a Liquidity Coverage Ratio (LCR) of 135% at end-FY21 compared to 136% at end-FY20.

Capitalisation Combined Building Block (BB) Assessment: Strong/Good

DBRS Morningstar considers that Lloyds has a sound capital position, which is supported by a steady and recurrent internal capital generation. The Group's CET1 ratio was 14.2% at end-Q1 2022 compared to 14.0% pro-forma for regulatory changes as of 1 January 2022 (otherwise 17.3% at end-FY21), that resulted in RWA inflation. This compares to an MDA trigger of 9.0% at end-March 2022 and a generic Group target for a CET1 ratio of c. 12.5%, plus a management buffer of c. 1%, with the Group having guided to paying down to this target level by end-2024.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/398090

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Governance (G) Factors
DBRS Morningstar views the Business Ethics sub-factor (within Corporate Governance) as a relevant ESG rating factor for the Group’s ratings. This is associated with the ongoing litigation issues related to customers who might have been affected by criminal activities linked to HBOS Reading. We note Lloyds has reported a charge of GBP 790 million in FY21 in respect of this issue (increasing the cumulative charges to GBP 1,225 million), and that the Group has reported that the final outcome could be significantly different once the re-review is concluded.

This G factor is new and was not present in the prior credit rating disclosure.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

Notes:
All figures are in GBP unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (19 July 2021) https://www.dbrsmorningstar.com/research/381742/global-methodology-for-rating-banks-and-banking-organisations. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (17 May 2022) https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings

The sources of information used for this rating include Morningstar Inc. and Company Documents, Lloyds 2021 Annual Report, FY21 and Q1 2022 Investor Presentations, FY21 Results News Release and Q1 2022 Transcript. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar 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.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.

For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. DBRS Morningstar understands further information on DBRS Morningstar historical default rates may be published by the Financial Conduct Authority (FCA) on its webpage: https://www.fca.org.uk/firms/credit-rating-agencies.

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/398089

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

Lead Analyst: Vitaline Yeterian, Senior Vice President, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: January 19, 2009
Last Rating Date: June 4, 2021

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