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Rating Action:

Moody's affirms Lloyds at Aa3 stable, lowers BFSR one notch to C

22 Jun 2009

Certain subordinated capital instruments also affected

London, 22 June 2009 -- Moody's Investors Service affirmed the senior unsecured ratings of Lloyds TSB Bank plc (Lloyds TSB) and Bank of Scotland plc at Aa3 with a stable outlook, as well as the A1 senior unsecured rating of the holding companies Lloyds Banking Group (LBG) and HBOS plc, also with a stable outlook. The short-term P-1 ratings of all entities were also affirmed. The Bank Financial Strength Rating ("BFSR") of Lloyds TSB was lowered one notch from C+ to C with a negative outlook (mapping to a baseline credit assessment of A3), and the BFSR of Bank of Scotland was confirmed at C- with a negative outlook (mapping to a baseline credit assessment of Baa2).

"The lowering of Lloyds TSB's BFSR by one notch to C incorporates the significant challenges lying ahead for the bank's management to continue the integration of HBOS and its subsidiaries, as well as the residual risk remaining in those assets that will not be covered under the Asset Protection Scheme" said Elisabeth Rudman, Vice President - Senior Credit Officer at Moody's and lead analyst for Lloyds.

Rudman continued: "With the BFSR at C we recognize these challenges, but also take into account the underlying strength of the business model of Lloyds TSB. Together with the risk shield provided by the Asset Protection Scheme ("APS") - which covers a significant amount of risks contained primarily within HBOS, but also within Lloyds - this should allow the group to emerge out of this integration process in a solid position as one of the UK's most important high-street lenders. This is also incorporated in the Aa3 long-term debt and deposit ratings, which continue to factor in high systemic support for this group".

The downgrade of certain subordinated capital instruments is detailed below.

The government backed ratings assigned to the debt instruments benefiting from UK government guarantee remain Aaa.

DOWNGRADE OF LLOYDS TSB BFSR TO C, NEGATIVE OUTLOOK

This rating action concludes the review for possible downgrade of Lloyds TSB's BFSR and subordinated capital instruments. The BFSR had been placed on review for possible downgrade on 2 June 2009.

The C BFSR with a negative outlook reflects the ongoing challenges facing Lloyds Banking Group in the integration of HBOS, the high provisions resulting from the recession in the UK as well as the pressure on underlying profitability due to the higher cost of deposit and market funding, whilst also recognizing the benefit of the insurance cover of the APS for the riskier assets and the additional government capital (GBP15.6bn of B shares issued as payment for participation in the APS).

Moody's believes that the APS (which is expected to be finalized in the next few months and will cover around GBP260bn of assets) and the accompanying government capital should provide a significant underpinning to the financial strength of Lloyds Banking Group. Indeed the availability and expected full implementation of the APS is a critical requirement for the BFSR at the current level, given the risks within the group's books, particularly the HBOS commercial property exposures and higher-risk mortgage exposures.

The bank has estimated that its pro-forma Tier 1 ratio (which includes the impact of the APS) will increase to 18.7% and the Core Tier 1 ratio to 14.5%. However, Moody's expects these high capital ratios to reduce over the near-term as the bank absorbs the GBP25bn first-loss piece, takes provisions on non-covered assets and absorbs costs associated with the integration of HBOS. In the absence of more detailed information, Moody's has made conservative assumptions regarding the performance of assets that will be outside the APS, and expects that the group's capital levels should still remain at a high level over the next 12 months in Moody's base case, but could drop much lower in our severe loss estimate.

The negative outlook indicates (i) the outstanding clarification as to which assets will be covered by the APS which will be crucial for the group's future performance, but also (ii) the continuing uncertain macroeconomic outlook, combined with the group's sensitivity to our stressed loss estimate, which could further weaken its capital base; and (iii) the challenges the group will need to manage for the next several years, namely the restructuring and full integration of HBOS.

Downward pressure on the BFSR would most likely emerge should further capital be required to support the business. An upgrade of the BFSR is not likely in the short to medium term - however, given the substantial franchise of the group in UK retail banking, we could envisage upward pressure on the BFSR following the successful integration of HBOS and the reduction of the remaining concentrations/ higher risk assets not covered by the APS.

CONFIRMATION OF BANK OF SCOTLAND C- BFSR, OUTLOOK NEGATIVE

This rating action concludes the review for possible downgrade of the Bank of Scotland's BFSR. The BFSR had been lowered to C- on February 16 2009 and the rating left under review for possible further downgrade in order to assess the impact of the planned UK Government Asset Protection Scheme (APS).

Based on the announcement that around 83% of the APS assets will come from HBOS, the Bank of Scotland will have insurance cover for nearly half its customer loan book. Over the long term, as the bank becomes fully integrated within Lloyds Banking Group and the assets that are outside the risk appetite of the group are wound down, we would expect the BFSR of Bank of Scotland to move up to the level of Lloyds TSB.

AFFIRMATION OF SENIOR DEBT RATINGS

The long-term rating of Lloyds TSB and Bank of Scotland was affirmed at Aa3 (stable outlook) and of LBG and HBOS at A1 (stable outlook). These ratings incorporate Moody's view of the very high probability of support from the Aaa-rated UK government for the group. In Moody's opinion uncertainty remains over potential requirements from the EU for LBG to reduce its high market shares in the UK as part of its agreement to approve the government support it has received. However, we expect that LBG will remain one of the largest retail and commercial banks in the UK and that this size and presence will result in the continuation of the very high probability of support from the UK government in the future.

DOWNGRADE OF CERTAIN SUBORDINATED CAPITAL INSTRUMENTS

The non-cumulative preference shares of all entities were affirmed at B3 (stable outlook), as their ratings are based on an Expected Loss analysis (for further information see the press release of 2 June 2009). The ratings of the remaining subordinated capital instruments of the Group are linked to the BFSRs of the banks (also incorporating parental support in the case of Bank of Scotland and HBOS, and one notch structural subordination for the holding companies), and have been adjusted as follows:

Lloyds TSB:

Senior Subordinated Debt from A3 (RUR) to Baa1 (negative outlook)

Junior Subordinated Debt from Baa1 (RUR) to Baa2 (negative outlook

Cumulative Preference Shares from Baa2 (RUR) to Baa3 (negative outlook)

Non-cumulative Preference Shares: affirmed at B3 (stable outlook)

Lloyds Banking Group:

Senior Subordinated Debt from Baa1 (RUR) to Baa2 (negative outlook)

Non-cumulative Preference Shares: affirmed at B3 (stable outlook)

Bank of Scotland:

Senior Subordinated Debt confirmed at Baa1 (negative outlook)

Junior Subordinated Debt from Baa1 (RUR) to Baa2 (negative outlook

Cumulative Preference Shares from Baa2 (RUR) to Baa3 (negative outlook)

Non-cumulative Preference Shares: affirmed at B3 (stable outlook)

HBOS:

Senior Subordinated Debt from Baa1 (RUR) to Baa2 (negative outlook)

Junior Subordinated Debt from Baa2 (RUR) to Baa3 (negative outlook)

Non-cumulative Preference Shares: affirmed at B3 (stable outlook)

SCOTTISH WIDOWS AND CLERICAL MEDICAL FINANCE RATING ACTIONS

Scottish Widows (SW):

Junior Subordinated Debt from Baa1 (RUR) to Baa2 (negative outlook)

Clerical Medical Finance (CMF):

Senior Subordinated Debt (guaranteed by Clerical Investment Group Ltd) confirmed at Baa1 (negative outlook)

Junior Subordinated Debt (guaranteed by Clerical Investment Group Ltd) from Baa1 (RUR) to Baa2 (negative outlook);

The rating actions on the subordinated debt of SW and CMF reflect the alignment of the insurance operations' subordinated ratings and outlooks to the subordinated ratings and outlooks of the corresponding banking operations within Lloyds. Moody's believes that Lloyds' capital base is increasingly managed centrally. The revised ratings and outlooks on the insurance subsidiaries therefore reflect Moody's view that the insurance subordinated ratings of SW and CMF are constrained by the ratings on the subordinated debt of the correspondent parent banking companies within Lloyds.

WITHDRAWAL OF RATINGS OF CHELTENHAM & GLOUCESTER

Moody's Investors Service has adjusted the ratings of Cheltenham & Gloucester in line with the ratings of Lloyds TSB: BFSR downgraded from C+ to C (negative outlook); Senior Subordinated Debt downgraded to Baa1 (negative outlook) from A3 (RUR).

Moody's will withdraw all outstanding ratings of Cheltenham & Gloucester, which is no longer authorized as a bank and has no banking assets or liabilities outstanding. For further details, please refer to Moody's Withdrawal Policy on moodys.com.

PREVIOUS RATING ACTIONS

The last rating action on the group was on 2 June 2009 when certain hybrid instruments were downgraded, and the C+ Lloyds TSB BFSR was placed on review for possible downgrade.

The principal methodologies used in rating this issuer were "Bank Financial Strength Ratings: Global Methodology" (February 2007) and "Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology" (March 2007), which can be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Credit Policy & Methodologies directory.

London
Elisabeth Rudman
VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

London
Johannes Wassenberg
Managing Director
Financial Institutions Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Moody's affirms Lloyds at Aa3 stable, lowers BFSR one notch to C
No Related Data.
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