Morningstar DBRS Confirms Lloyds Bank's Long-Term 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 Intrinsic Assessment (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 is Stable. The IA for the Bank remains at AA (low) and the Support Assessment of the Group remains at SA3. HBOS plc's credit ratings were discontinued for analytical reasons. Please see a full list of the rating actions at the end of this press release.

KEY CREDIT RATING CONSIDERATIONS
The confirmation of Lloyds' credit ratings reflects its leading retail and commercial banking franchise in the UK, its conservative risk profile and sound asset quality with low levels of non-performing loans (Stage 3), and its good funding and liquidity positions. The ratings also take into account that profitability has been under pressure in recent years due to the building up of provisions to cover potential costs associated with operational risk issues, including the more recent provisions for the motor finance commissions arrangements. The credit ratings also reflect that capital levels have declined from higher levels and that regulatory cushions over minimum requirements are lower than most domestic and international peers. However, Morningstar DBRS considers its relatively low capital cushions to be partly mitigated by the Group's strong and recurrent internal capital generation, which is supported by the expectation that revenues from the structural hedge will be significantly higher in 2025 and 2026.

The potential negative impact of the FCA review and the Court of Appeal's rulings associated with motor financing commissions remain highly uncertain in Morningstar DBRS' view. Further clarity from the Court of Appeal case is expected by the end of July 2025. Furthermore, the FCA plans to announce the next steps about its investigation of motor finance discretionary commissions at the same time. Morningstar DBRS still expects that the financial impact of these court rulings and the FCA review will be spread over time. Whilst Lloyds took steps in provisioning for this matter in 2024 and 2023, and the Group has a strong earnings capacity to absorb additional provisions if required, Morningstar DBRS will continue to monitor any potential impact on Lloyds' financial and franchise positions.

The Group's IA of A (high) has been assigned at the high point of the IA range, which takes into account that we consider Lloyd's risk profile to be stronger than reflected in the scorecard results, which are affected by the inclusion of purchased originated credit impaired loans in the calculation of the risk ratios and capital in the scorecard.

CREDIT RATING DRIVERS
Over the medium term, an upgrade of the credit ratings would require the Group to sustain strong profitability metrics, as well as strong capitalisation levels, whilst maintaining a solid risk profile. It would also require the Group to demonstrate that it has satisfactorily resolved outstanding operational issues with no major impact on the franchise or business.

A downgrade of the credit ratings would be driven by a deterioration in its risk profile or profitability, and any weakening in the capital position. It would also arise if the franchise or capital position weakens as a result of material fines or litigation costs.

CREDIT RATING RATIONALE
Franchise Combined Building Block Assessment: Strong
Lloyds is the largest UK provider of mortgages, cards, loans, and transport, and it is the UK's only provider of banking, insurance, and wealth. 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 for UK mortgages of around of 19.9%, small and medium-size enterprises, home insurance (15% market share) and motor finance (15% market share). In February 2025, the Group also updated the market on the second phase of its strategic objectives for 2025-26. Lloyds expects revenues to grow significantly in the next two years, supported by a higher contribution from the structural hedge. As a result, the Group is guiding for a higher net interest income (NII) in 2025 than in 2024 and for the return on equity to remain at 13.5% in 2025 and to be higher than 15% in 2026. The CET1 is expected to decrease to 13.0% in 2026 by distributing excess capital to shareholders.

Earnings Combined Building Block Assessment: Good
Morningstar DBRS views Lloyds' earnings ability as solid, supported by sound revenue generation, which is underpinned by its retail market-leading positions in the UK, good cost discipline, and low risk profile that supports low levels of loan impairment charges. Lloyds reported underlying profit before tax of GBP 6.3 billion in 2024, down from GBP 7.8 billion in 2023, which excludes operating lease depreciation, largely impacted by GBP 899 million of provisions, which included an additional GBP 700 million in relation to motor finance commissions arrangements. The underlying return on tangible equity (ROTE) was 12.3% in 2024, down from 15.8% in 2023, largely impacted by the higher provisions. Excluding the motor finance provisions, the ROTE was 14.0% in 2024. Lloyds' 2024 underlying operating income was 2.4% lower year over year (YOY), largely reflecting a 6.7% decrease in NII. This reflected strong domestic mortgage competition and deposits repricing at higher rates, which was not fully offset by revenues from the structural hedge. The banking net interest margin (NIM) was 2.95% in 2024, down from 3.11% in 2023, although pressure in NIM eased in recent quarters and has slightly improved quarter over quarter since Q2 2024. The Group expects revenues from the structural hedge to be GBP 1.2 billion higher in 2025 and GBP 1.5 billion higher in 2026. Lloyds generally maintains good cost discipline although underlying operating expenses have gradually increased since 2020, reflecting higher investment in IT and inflation. The underlying cost-to-income ratio weakened to 60.4% in 2024, which compares to 54.7% in 2023, although Lloyds aims to achieve a cost-to-income ratio of below 50% by 2026. The Group's cost of risk was 10 basis points (bps) in 2024, compared to 7 bps in 2023 from 32 bps in 2022.

In Q1 2025, Lloyds' underlying profit decreased to GBP 1.5 billion, down 12.8% YOY largely reflecting growth of operating expenses driven by severance costs and higher loan impairment charges driven by a GBP 100 million model adjustment to reflect the potential economic impact from U.S. tariffs. Results, however, were also supported by growth of NII YOY largely driven by higher revenues from the structural hedge.

Risk Combined Building Block Assessment: Good
Morningstar DBRS considers that Lloyds has a generally conservative risk profile. The Group's main risk is credit risk, largely arising from its lending exposures, and the Group has a sound asset quality with low levels of Stage 3 loans and low levels of loan impairment losses. The Group's lending operations are predominantly UK based, with the book weighed towards retail loans, which account for approximately 81% of total gross loans and advances to customers. The Group's asset quality remained sound despite some signs of deterioration in the corporate and institutional banking portfolio associated to a few individual clients. Total Stage 3 loans (on an underlying basis which excludes HBOS acquisition) totalled GBP 9.2 billion at the end of Q1 2025, up 2.5% since FY2024 although still lower than GBP 10. 1 billion at YE2023. The Stage 3 loan ratio was 2.0% at the end of Q1 2025, slightly improved from 2.2% at YE2023. Stage 2 loans decreased in FY2024 by 15% YOY and a further 2% in Q1 2025 to GBP 47.3 billion to represent 10.4% at YE2024 [Annual report, p.164]and 10.1% at the end Q1 2025, down from to 12.5% at YE2023.

Funding and Liquidity Combined Building Block Assessment: Strong/Good
Lloyds has a strong funding profile, which is underpinned by a large deposit franchise in the UK, reflective of Lloyds' solid domestic retail franchise and strong customer market share. Customer deposits were GBP 487. 7 billion at the end of Q1 2025, up from GBP 482.7 billion at YE2024 and GBP 471.4 billion at YE2023. The growth of deposits has been largely driven by growth of retail savings and wealth deposits, as customers focused on higher rate term deposits. At YE2024, around 66% of total customer deposits were related to retail and 34% to corporate deposits. Morningstar DBRS notes 56% of total deposits were classified as insured at the end of Q1 2025. In addition, Lloyds' wholesale funding of GBP 89 billion at the end of March 2025 is well diversified by instruments, currencies, and maturities. Refinancing risk is manageable. Lloyds expects to issue wholesale funding up to around GBP 9 billion in 2025, around GBP 2.8 billion of which was already completed by April 2025. The Group's liquidity is sound with a GBP 133 billion portfolio of highly liquid assets at the end of Q1 2025. Lloyds' liquidity coverage ratio was 145% at the end of Q1 2025, stable from YE2024 and YE2023 and the net stable funding ratio was unchanged at 128% at the end of Q1 2025.

Capitalisation Combined Building Block Assessment: Good
Morningstar DBRS views Lloyds's capitalisation as sound, supported by strong and resilient earnings generation capacity, although capital ratios have declined since 2021. The Group's pro forma CET1 ratio was 13.5% at YE2024, down from 13.7% at YE2023, largely reflecting dividend payment and share buybacks and, to a lesser extent, some growth of risk-weighted assets driven by retail-secured CRD IV model updates. At the end of Q1 2025, the CET1 ratio was unchanged at 13.5% and the Group has a narrow capital cushion over the minimum regulatory requirement of around 12% of CET1. Morningstar DBRS notes that capital cushions over minimum regulatory requirements are expected to further decline as the guidance is to further reduce the CET1 ratio to 13% by YE2026. However, Morningstar DBRS consider low capital cushions to be partly mitigated by the Group's strong internal capital generation. For 2025 and 2026 the Group targets a capital generation excluding capital distributions of 175 bps and 200 bps, respectively. Additionally, Lloyds' MREL was 30.4% at the end of Q1 2025, down from 32.2% at the end of Q4 2024, and above the minimum regulatory requirements of 27.3%.

Further details on the Scorecard Indicators and Building Block Assessments can be found at https://dbrs.morningstar.com/research/454514/.

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 recognised in Q4 2023 following the UK's FCA launching a review in January 2024 into historical motor commission arrangements (Black Horse Limited which is fully owned by Lloyds). Further in Q4 2024, the Group made an additional GBP 700 million to cover potential redress and costs associated with some decisions taken by Court of Appeal regarding broker commissions paid to car dealerships. These rulings have been appealed, and the Supreme Court is expected to come up with a final decision by the end of July. Meanwhile, the FCA also announced that it will conclude its motor finance review within six weeks after the Supreme Court's decision. Whilst there is high uncertainty around the final outcome of both the Supreme Court ruling and the FCA, we expect the financial impact to be spread over time.

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 customer claims received from the insurance business in Germany.

There were no Environmental factors 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 Factors in Credit Ratings (16 May 2024) https://dbrs.morningstar.com/research/454196

Notes:
All figures are in British pound sterling unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (4 June 2024) https://dbrs.morningstar.com/research/433881. In addition Morningstar DBRS uses the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (16 May 2024) https://dbrs.morningstar.com/research/454196 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 these credit ratings include Morningstar Inc. and company documents, Lloyds 2024 Annual Report, and FY24 and Q1 2025 Investor Presentations, FY24 and Q1 2025 Reports and Transcript, 2024 Sustainability Report, and FY24 and Q1 2025 Pillar 3 Disclosures. Morningstar DBRS considers the information available to it for the purposes of providing these credit ratings to be of satisfactory quality.

With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, these are unsolicited credit ratings. These credit ratings were 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's trends 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://dbrs.morningstar.com/research/454516/.

These credit ratings are endorsed by DBRS Ratings GmbH for use in the European Union.

Lead Analyst: Maria Rivas Escrigas, Senior Vice President, Sector Lead
Rating Committee Chair: Elisabeth Rudman, Managing Director
Initial Rating Date: 19 January 2009
Last Rating Date: 22 May 2024

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