DBRS Confirms Lloyds Bank at A (high), Trend now Positive; Ring-Fencing Transfer Scheme Completed

DBRS Ratings Limited (DBRS) confirmed the ratings of Lloyds Banking Group plc (Lloyds or the Group) and its related entities, including the Group’s ‘A’ Long-Term Issuer Rating and Lloyds Bank plc’s (the Bank) A (high) Long-Term Issuer Rating. The trend on these ratings was revised to Positive. The Intrinsic Assessment (IA) for the Bank is A (high). The Support Assessment of the Group remains SA3 and its Long-Term Issuer Rating is positioned one notch below the Bank’s IA. Please see a full list of the rating actions at the end of this press release.

KEY RATING CONSIDERATIONS
The change in the trend to Positive from Stable reflects Lloyds’ improving profitability and the reduction of the drag on statutory earnings from legacy conduct issues, as well as its achieved efficiency targets and cost savings progress. DBRS expects the Group’s statutory profitability to continue to improve as Lloyds gradually resolves outstanding litigation and conduct issues.

The Bank’s IA of A (high) 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. Lloyds also maintains a conservative risk profile and strong asset quality. Asset quality ratios have stabilised at low levels following a sharp improvement in previous years. Despite the drag from conduct issues on statutory profits of the Group in recent years, the Group’s capital position remains strong and compares well with many domestic and international peers.

The establishment of the new group structure, in May 2018, to be compliant with UK ring-fencing requirements, has led to Lloyds Bank becoming the ring-fenced entity. Approximately 97% of the Group’s loans and advances are within this entity. The Group has also created a new non-ring-fenced entity, Lloyds Bank Corporate Markets plc (LBCM). DBRS has not currently assigned a public rating to LBCM.

RATING DRIVERS
A track record of reduced drag from conduct provisions, resulting in statutory earnings stabilising at levels more in line with the Group’s strong underlying profitability would maintain positive rating pressure.

Negative pressure is unlikely given the positive trend, however this could arise from a material deterioration in asset quality or a higher than expected drag from litigation and conduct on earnings. Potential adverse economic effects of the UK’s exit from the EU on the Group’s risk profile could also exert downward pressure on the ratings.

RATING RATIONALE
The Group’s underlying earnings generation capacity remains strong, supported by the significant domestic franchise, as well as the market leading cost efficiency and the low cost of risk. 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 and investing more than GBP 3 billion in strategic initiatives.

The Group’s statutory profitability has been weighed down by legacy issues, most notably in the form of conduct provisions, such as Payment Protection Insurance (PPI). Lloyds has reduced the gap between statutory and underlying profits in recent years. DBRS expects the gap to continue to narrow as the Group gradually resolves outstanding litigation and conduct issues, even if PPI charges could potentially add to earnings volatility as the PPI deadline (August 2019) approaches.

DBRS views Lloyds’ risk profile as conservative, benefitting from conservative underwriting, the focus on mortgage lending, and the substantial deleveraging of the run-off portfolio in recent years. The Group’s loan portfolio consists predominantly of UK mortgages (64% of total loans and advances to customers at end-2017). The risk in UK consumer finance, consisting of credit cards, motor finance and leasing and personal loans, is mitigated by moderate risk appetite. The acquisition of the MBNA loan book in June 2017 increased the share of cards in total customer loans from 2.1% to 3.8% and had a neutral impact on the Group’s asset quality ratios. The commercial banking portfolio represented 21% of loans at end-2017. The Run-off portfolio has continued to reduce, contributing to a reduction in the risk profile, and at end-2017 totalled GBP 8.5 billion (1.8% of customer loans). Asset quality remains strong. 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-2017, impaired loans accounted for 1.6% of gross loans and advances, down 20 basis points (bps) compared to end-2016. The quality of the mortgage book is solid with the share of impaired loans at 1.3% at end-2017, 10 bps down year-on-year (YoY). DBRS notes that the uncertainty around the terms of UK’s departure from the EU could lead to a deterioration in UK macroeconomic conditions. However, DBRS would not expect this potential outcome to have a significant impact on the Group’s risk profile given the conservative underwriting and the robust liquidity and capital profiles.

Lloyds’ funding profile is strong, driven by its leading position in UK current accounts and savings and access to a range of funding markets. Despite an increase in customer loans during 2017, mainly due to the acquisition of MBNA, the loan-to-deposit ratio remained stable at 110%. The Group’s wholesale funding requirement has decreased by 9% during 2017 to GBP 101 billion and 71% of this had maturities in excess of one year. An increased share of funding is raised by the holding company, as needed to transition towards final UK Minimum Requirements for Own Funds and Eligible Liabilities (MREL). The Group maintains a solid liquidity profile, with a liquidity portfolio of GBP 120 billion at end-2017, equivalent to over four times the Group’s short-term wholesale funding (excluding derivative collateral margins and settlement). The Group comfortably meets the Liquidity Coverage Ratio (LCR) requirements, with a ratio of 125% at end-1Q18.

DBRS views Lloyds as having a strong capital profile, comparing favourably with many domestic and international peers. At end-1Q18 the fully loaded Common Equity Tier 1 (CET1) ratio was 14.1%, up 20 bps sequentially and YoY. DBRS views the Group as having strong underlying CET1 capital generation capacity, equivalent to 245 bps in 2017 (pre-dividend and excluding acquisitions). The UK leverage ratio was 5.3% at end-1Q18. With a transitional total capital ratio of 21.2% at end-2017 the Group remains well positioned to meet MREL requirements from 2020. During 2016 and 2017 the Group issued senior unsecured securities from the holding company, which, while not included in total capital, are eligible to meet MREL. The transitional MREL ratio was 27.4% at end-1Q18. The IFRS 9 impact on CET1 on day 1, which was implemented as of 1 January 2018, was 30 bps before transitional relief and only 1 bp after the transitional relief.

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 (May 2017). 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, company documents and Prudential Regulation Authority. 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, Senior Vice President, Global Financial Institutions
Initial Rating Date: January 19, 2009
Last Rating Date: October 9, 2017

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