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

DBRS Ratings Limited (Morningstar DBRS) 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). Lloyds’ Long-Term Issuer Rating is positioned one notch below the Bank’s IA reflecting the structural subordination of the holding company. Concurrently, the Bank’s R-1 (middle) Short-Term Issuer Rating was also confirmed. The trend on all credit ratings remains Stable. 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 CREDIT RATING CONSIDERATIONS
The confirmation of the long-term credit ratings reflects the Group’s powerful retail and commercial banking franchise in the UK which is characterised by leading market shares across most retail and business segments, and that its profitability is underpinned by profitable core activities, a generally low risk profile, and strict cost discipline. In spite of new mortgage lending in the UK being under pressure due to higher interest rates and high competition, Lloyds has benefited from higher net interest margins. Meanwhile, Lloyds’ asset quality metrics remain good given the low unemployment rate in the UK and a resilient economic environment. The credit ratings also reflect a robust funding and liquidity position, as well as solid albeit declining capital levels.

CREDIT RATING DRIVERS
An upgrade of the long-term credit ratings would require the Group to sustain strong profitability metrics over the medium term, as well as strong capitalisation levels, whilst maintaining a solid risk profile.

The long-term credit ratings would be downgraded if the Group experienced important deterioration in its risk profile, and/or a material deterioration in profitability, and/or significantly reduced capital.

CREDIT RATING RATIONALE

Franchise Combined Building Block (BB) Assessment: Strong
Lloyds Banking Group plc is one the largest UK banking groups, with total assets of GBP 881.5 billion at end-2023, and has a UK centric business model. The Group has a well-entrenched franchise in its domestic market, predominantly in retail and commercial banking, insurance and long-term investments, with strong market shares across various products. The Group is the largest UK provider of mortgages, cards, loans and transport, and it is the UK’s only provider of banking, insurance and wealth.

Earnings Combined Building Block (BB) Assessment: Good
Morningstar DBRS views Lloyds as having a sound earnings generation, generally supported by resilient core revenues and disciplined cost management. Lloyds reported a solid statutory profit after tax for the year 2023 of GBP 5.5 billion, up 41% from GBP 3.9 billion in 2022 (restated for IFRS 17), translating into a return on tangible equity (ROTE) of 15.8% in 2023 (and significantly up from 9.8% in 2022). The improvement in profitability in 2023 was mainly driven by higher net interest income (NII) thanks to higher NIM, despite that new lending volume was broadly flat year-over-year (YoY), as well as lower impairment charges YoY. In spite of investments and inflation, Lloyds’s efficiency levels remained well managed with a reported cost-to-income ratio of 54.7% in 2023, although above 51.1% in 2022.

The Group’s cost of risk decreased to 7 bps in 2023 from 32 bps in 2022. Excluding both the significant write-back in Q4 2023 and economic outlook improvements across the year, Lloyds calculated its cost of risk would be 29 bps in 2023. In Q1 2024, the cost of risk was 6 bps, however, excluding the impact from Lloyds’ updated economic outlook, the cost of risk was 23 bps. The Group’s guidance on cost of risk for 2024 remains below 30 bps.

In Q1 2024, Lloyds’ statutory profit after tax decreased to GBP 1.2 billion, down 26% YoY as the Group’s NII decreased to GBP 3.2 billion, down 4% quarter-over-quarter (QoQ) and down 10% YoY, partly due to NIM pressure (295 bps in Q1 2024), and lower lending volume (mortgages and SMEs) in spite of lending growth in unsecured loans, motor and cards. In Q1 2024, the Group’s ROTE was 13.3%, which compares well to domestic peers but slightly weaker internationally.

Risk Combined Building Block (BB) Assessment: Good
Morningstar DBRS views Lloyds’s risk profile as generally conservative, with the loan book largely comprised of 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 80% 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 2.35% at end-Q1 2024, slightly above 2.23% at end-2023 and 2.29% at end-Q1 2023. The Stage 2 loans accounted for 11.1% at end-Q1 2024, down from 12.5% at end-2023 and 13.3% at end-Q1-2023.

Funding and Liquidity Combined Building Block (BB) Assessment: Strong/Good
Lloyds has a robust funding profile, supported by the strong deposit franchise in the UK. The Group’s net loan-to-deposit ratio was 95% at end-2023. Customer deposits slightly decreased to GBP 471.4 billion at end-2023, down 0.8% from GBP 475.3 billion at end-2022. Morningstar DBRS notes 57% of total deposits were classified as insured at end-2023. In addition, Lloyds’ total wholesale funding decreased to GBP 98.7 billion at end-2023 (down 1.6% compared to GBP 100.3 billion at end-2022) driven by a small reduction in money market funding. The Group's liquidity is sound with a GBP 136 billion portfolio of highly liquid assets as well as GBP 47 billion available borrowing capacity at central banks at end-2023. Lloyds’ Liquidity Coverage Ratio (LCR) was 142% at end-2023 (144% at end-2022). The Group’s net stable funding ratio (NSFR) was unchanged at 130% at end-2023.

Capitalisation Combined Building Block (BB) Assessment: Good
Morningstar DBRS considers that Lloyds has a sound capital position is supported by its capacity to generate earnings although capital ratios have declined from very high levels in 2021. The Group's CET1 ratio was 13.7% at end-2023 down from 14.1% at end-2022, largely on dividends and share buybacks and to a smaller extent increased RWA due to CRD IV. The Group's CET1 ratio was 13.9% at end-Q1 2024 pro-forma for dividends and share buybacks. Based on Lloyds’ current macroeconomic assumptions, the Group has guided to further paying down to a CET1 ratio of approximately 13.5% by end 2024 and 13.0% by end 2026. This compares to the Group’s CET1 capital requirement now around 12%. Additionally, Lloyds’ MREL was 31.9% at end-2023, above the regulatory requirements of 27.3%.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/433112.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Social (S) Factors
Morningstar DBRS views the Product Governance sub-factor as relevant but it does not affect the credit rating or trend assigned to Lloyds. This factor is new and was not present in the prior credit rating disclosure. A provision of GBP 450 million reflecting operational and legal expenses, as well as redress costs, was recognized in Q4 2023 following the UK Financial Conduct Authority (FCA) launching a review in January 2024 into historical motor commission arrangements (Black Horse limited which is fully owned by Lloyds). The final outcome still remains highly subject to variation at this point, however, Lloyds indicated “the ultimate financial impact could materially differ from the amount provided, both higher or lower.”

Governance (G) Factors
Morningstar DBRS views the Business Ethics sub-factor as relevant but it does not affect the credit rating or trend assigned to Lloyds. This is associated with the ongoing litigation issues related to customers who might have been affected by criminal activities linked to HBOS Reading but also customers claims received from the insurance business in Germany. When resolved, both outcome could be different from the respective provisions that have been booked.

There were no Environmental factor(s) that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23, January 2024), https://dbrs.morningstar.com/research/427030/morningstar-dbrs-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 (15 April 2024) https://dbrs.morningstar.com/research/431155/global-methodology-for-rating-banks-and-banking-organisations. In addition, Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (23 January 2024) https://dbrs.morningstar.com/research/427030/morningstar-dbrs-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies

The sources of information used for this credit rating include Morningstar, Inc. and company documents, Lloyds 2023 Annual Report, FY23 and Q1 2024 Investor Presentations, FY23 Results News Release, Q1 2024 Reports and Transcript, 2023 Sustainability Report and Pillar 3 Disclosures. Morningstar DBRS considers the information available to it for the purposes of providing this credit 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

Morningstar DBRS does not audit the information it receives in connection with the credit 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. Morningstar DBRS' outlooks and credit ratings are under regular surveillance.

For further information on Morningstar DBRS historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://registers.esma.europa.eu/cerep-publication. For further information on Morningstar DBRS historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.

The sensitivity analysis of the relevant key credit rating assumptions can be found at: https://www.dbrsmorningstar.com/research/433111.

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

Lead Analyst: Vitaline Yeterian, Senior Vice President - European Financial Institution Ratings
Rating Committee Chair: William Schwartz, Senior Vice President - Global Fundamental Ratings, Credit Practices
Initial Rating Date: 25 January 2001
Last Rating Date: May 31 2023

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