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Rating Action:

Moody's assigns Baa2/P-2 deposit and issuer ratings to Tesco Personal Finance Plc; outlook positive

29 Jun 2018

London, 29 June 2018 -- Moody's Investors Service ("Moody's") has today assigned Baa2 long-term local- and foreign-currency deposit ratings, Baa2 long-term local-currency issuer rating, Prime-2 short-term local- and foreign-currency deposit ratings, and Prime-2 short-term local-currency issuer rating to Tesco Personal Finance Plc (Tesco Bank). The outlook on the long-term ratings is positive. Moody's also assigned a Counterparty Risk Assessment (CR Assessment) of A3(cr)/Prime-2(cr), a Counterparty Risk Rating (CRR) of Baa1/Prime-2, as well as a baa2 baseline credit assessment (BCA) and baa2 Adjusted BCA to the bank. This is the first time Moody's has assigned credit ratings to Tesco Bank.

At the same time, Moody's assigned Baa3 long-term local- and foreign-currency issuer ratings with positive outlook and Prime-3 short-term local- and foreign-currency issuer ratings to Tesco Personal Finance Group Limited (TPFG), the holding company of Tesco Bank.

A full list of assigned ratings is provided at the end of this press release.

RATINGS RATIONALE

RATIONALE FOR THE BASELINE CREDIT ASSESSMENT

Tesco Bank's baa2 BCA reflects the bank's: (1) strong risk-weighted capital and leverage metrics; (2) good profitability, albeit likely to remain below historical levels given the bank's shift to lower margin mortgages; and (3) solid retail franchise supported by the Tesco brand and a wide distribution network. These strengths are balanced against (1) a loan book, which will remain dominated by unsecured lending and (2) potential risks related to rapid expansion and high growth of mortgage lending.

Moody's views Tesco Bank's capital position as a key strength for the rating. The rating agency believes Tesco Bank's capitalisation is sufficient to absorb moderate unexpected losses, meet regulatory requirements, and support the bank's growth ambitions. Under Moody's definition, Tesco Bank's tangible common equity (TCE) to risk-weighted assets (RWA) was 15.9% at the end of February 2018, in line with its peers. However, the bank's leverage ratio, TCE to Tangible Assets, was 10.3% at the same time. This is strong compared to most mortgage lenders, although partly reflects the higher risk and therefore capital requirements associated with its unsecured lending.

Tesco Bank's profitability is strong, reporting net income to tangible assets of 1.0% for the year ending February 2018, and Moody's expects it to remain above mortgage-focused peers over the outlook period. However, the bank's three-year average net income to tangible assets is 1.3% and the rating agency expects that Tesco Bank's net income to tangible assets will remain below this going forward. The expectation of lower-than-historical return on assets is driven by the bank's continued focus on increasing the proportion of mortgage lending in its loan book, which will yield lower returns than its unsecured lending.

The linkage to Tesco Plc (Ba1 positive), Tesco Bank's ultimate parent company, supports the bank's financial profile by providing a strong and wide distribution network. Through the distribution network, the bank offers its wide range of retail banking products, including mortgages, credit cards, insurance, ATMs, and travel money. However, Tesco Bank's baa2 BCA also reflects the risks related to close linkage with its parent company. While Tesco Bank benefits from a high degree of capital, funding and operational independence from its parent company, it could be negatively affected by a deterioration in its parent's creditworthiness. Moody's therefore limits Tesco Bank's BCA to two notches above the long-term rating on Tesco Plc, despite the bank's baa1 financial profile.

Tesco Bank has a riskier lending profile than most of its rated UK peers, given its high proportion of unsecured loans. Unsecured credit cards and personal lending dominate Tesco Bank's loan book, accounting for 74.4% at the end of February 2018, while most of its UK peers have mortgage-focused loan books. Moreover, Tesco Bank is pursuing an aggressive mortgage growth strategy and Moody's therefore view risks related to potential weakening underwriting standards and an unseasoned loan book as elevated during the bank's growth period. At the end of February 2018, the bank had a 1.8% problem loan ratio. The rating agency expects this to slightly increase over the next 12-18 months, because of an expected weakening of the operating environment and increased impairments as Tesco Bank's mortgage portfolio matures.

RATIONALE FOR THE LONG-TERM DEPOSIT AND ISSUER RATINGS

Tesco Bank is domiciled in the UK, a jurisdiction that is subject to the EU Bank Recovery and Resolution Directive (BRRD), which Moody's considers an Operational Resolution Regime. Moody's assumes residual tangible common equity of 3% and losses post-failure of 8% of tangible banking assets, a 25% run-off in "junior" wholesale deposits, a 5% run-off in preferred deposits, and assigns a 25% probability to deposits being preferred to senior unsecured debt. These are in line with Moody's' standard assumptions. Particular to Tesco Bank, Moody's assumes the proportion of deposits considered junior to be zero, relative to the standard assumption of 26%, due to the bank's policy of accepting only preferred retail deposits, rather than junior corporate funds.

Given the above, as well as Moody's expectations in regard to the evolution of Tesco Bank's liability structure going forward, the rating agency considers that the bank's deposits and senior unsecured debt are likely to face moderate loss-given-failure, due to the limited loss absorption provided by the modest amount of unsecured debt outstanding. This results in a Preliminary Rating Assessment for deposits and for senior unsecured debt at the same level as its BCA, baa2. Since Moody's considers the probability of government support for Tesco Bank's senior liabilities to be low, because of its limited interconnections with other financial institutions and relatively small size, the rating does not incorporate any uplift from government support, and the final deposits and issuer ratings are therefore positioned at Baa2.

By applying the same assumptions, the Baa3 long-term issuer ratings assigned to TPFG reflects: (1) Tesco Bank's baa2 BCA; (2) the results of Moody's' Advanced Loss Given Failure (LGF) analysis, implying that holders of structurally subordinated senior unsecured debt issued by TPFG would face high loss-given-failure, resulting in a one-notch negative adjustment from the BCA; and (3) a low probability of government support.

RATIONALE FOR THE COUNTERPARTY RISK RATINGS

Moody's Counterparty Risk Ratings (CRRs) are opinions of the ability of entities to honour the uncollateralized portion of non-debt counterparty financial liabilities (CRR liabilities) and also reflect the expected financial losses in the event such liabilities are not honoured. CRR liabilities typically relate to transactions with unrelated parties. Examples of CRR liabilities include the uncollateralized portion of payables arising from derivatives transactions and the uncollateralized portion of liabilities under sale and repurchase agreements. CRRs are not applicable to funding commitments or other obligations associated with covered bonds, letters of credit, guarantees, servicer and trustee obligations, and other similar obligations that arise from a bank performing its essential operating functions.

The Baa1 CRR takes into account: (1) Tesco Bank's baa2 BCA; (2) low loss-given-failure under Moody's Advanced LGF analysis, resulting in a one-notch uplift from the BCA; and (3) a low probability of government support.

RATIONALE FOR THE COUNTERPARTY RISK ASSEMENTS

As part of today's rating action, Moody's also assigned a CR Assessment of A3(cr)/Prime-2(cr) to Tesco Bank, two notches above the baa2 BCA. The CR Assessment is driven by the banks' BCA and by the amount of subordinated instruments likely to shield counterparty obligations from losses.

CR Assessments are opinions of how counterparty obligations are likely to be treated if a bank fails, and are distinct from debt and deposit ratings in that they: (1) consider only the risk of default rather than both the likelihood of default and the expected financial loss suffered in the event of default; and (2) apply to counterparty obligations and contractual commitments rather than debt or deposit instruments. Moody's CR Assessment captures the probability of default on certain senior obligations, rather than expected loss. Therefore, the rating agency focuses purely on subordination and take no account of the volume of the instrument class.

RATIONALE FOR THE POSITIVE OUTLOOK

The positive outlook reflects the positive outlook on Tesco Plc and Moody's view that Tesco Bank will continue to perform in line with that of its baa1 financial profile, one notch above its current baa2 adjusted BCA, despite some weakening of profitability driven by increased mortgage lending and an expected weakening in the UK operating environment because of Brexit. The outlook also takes into account Moody's expectations for the evolution of the bank's liability structure over the next two years.

WHAT COULD MOVE THE RATINGS UP

Tesco Bank's deposit and issuer ratings could be upgraded because of: (1) an increase in its BCA, resulting from an upgrade of its parent, Tesco Plc, while the bank maintains or improves its financial profile; or (2) the issuance of a large amount of senior or subordinated bail-in-able debt by the bank or by its holding company.

WHAT COULD MOVE THE RATINGS DOWN

The BCA of Tesco Bank could be downgraded if the rating of Tesco Plc were downgraded. Tesco Bank's BCA could also be downgraded as a result of: (1) a deterioration in asset quality beyond Moody's expectations; (2) high credit growth not supported by organic capital generation, leading to a material decline in capital ratios; and/or (3) a significant deterioration in its liquidity and funding metrics.

A lower BCA would likely lead to a downgrade in all ratings. The ratings could also be lowered should unsecured debt decline relative to the bank's total balance sheet, resulting in higher loss-given-failure for senior depositors.

LIST OF AFFECTED RATINGS

..Issuer: Tesco Personal Finance Group Limited

Assignments:

....Long-term Issuer Rating (Local and Foreign Currency), Assigned Baa3 Positive

....Short-term Issuer Rating (Local and Foreign Currency), Assigned P-3

Outlook Actions:

....Outlook, Assigned Positive

..Issuer: Tesco Personal Finance Plc

Assignments:

....Long-term Issuer Rating (Local Currency), Assigned Baa2 Positive

....Short-term Issuer Rating (Local Currency), Assigned P-2

....Long-term Deposit Rating (Local and Foreign Currency), Assigned Baa2 Positive

....Short-term Deposit Rating (Local and Foreign Currency), Assigned P-2

.... Baseline Credit Assessment, Assigned baa2

.... Adjusted Baseline Credit Assessment, Assigned baa2

.... Counterparty Risk Assessment, Assigned A3(cr)

.... Counterparty Risk Assessment, Assigned P-2(cr)

.... Counterparty Risk Rating (Local and Foreign Currency), Assigned Baa1

.... Counterparty Risk Rating (Local and Foreign Currency), Assigned P-2

Outlook Actions:

....Outlook, Assigned Positive

The principal methodology used in these ratings was Banks published in June 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Aleksander Henskjold
Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Nicholas Hill
MD - Banking
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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