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Rating Action:

Moody's assigns Baa2/P-2 ratings to TSB Bank plc and Baa3 ratings to TSB Banking Group plc

22 Jul 2015

London, 22 July 2015 -- Moody's Investors Service has today assigned Baa2 long-term deposits and issuer ratings, and P-2 short-term deposits ratings, to TSB Bank plc (TSB). The outlook on the long-term ratings is positive. Moody's also assigned a Counterparty Risk Assessment (CRA) of A2(cr)/ P-1(cr) to the bank. This is the first time Moody's has assigned credit ratings to TSB.

Moody's also assigned a Baa3 issuer rating to TSB Banking Group plc, TSB's holding company. The outlook is stable. The rating of the dated subordinated instruments issued by TSB Banking Group plc is also Baa3.

TSB's baa2 BCA reflects the (1) high quality of its existing loan portfolio; (2) protection provided by Lloyds Banking Group plc (LBG, Baa1 positive) against legacy litigation and conduct remediation costs; (3) strong capital and leverage metrics; and (4) very low reliance on wholesale funding given its stable retail deposit base. These strengths are balanced against its (1) relatively short track record as an independent entity with limited financial history; (2) plans for accelerated credit growth above market average within an increasingly competitive environment; (3) high operational risk arising from the need to migrate its IT platform within ten years; and (4) expected low levels of profitability given the large cost base it has inherited.

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

RATINGS RATIONALE

TSB'S BCA IS SUPPORTED BY THE UK'S VERY STRONG- MACRO PROFILE

As a domestic UK bank with a large deposit and lending base, TSB's operating environment is influenced by the UK's economic performance and its Macro profile is thus aligned with that of the UK at Very Strong-. UK banks benefit from operating in a wealthy and developed country with a very high degree of economic, institutional and government financial strength as well as very low susceptibility to event risk. The main risks to the banking system stem from the high level of indebtedness of UK households, which are thus sensitive to changes in interest rates. UK banks are largely funded by deposits and banks' funding structures have remained relatively stable in the past few years, with slight increases in capital as well as declines in short-term funding. The UK banking sector is relatively concentrated, but the price-setting power of large banks is somewhat challenged by competition from the shadow banking market.

STRONG ASSET QUALITY AND LIMITED EXPOSURE TO CONDUCT RISK OFFSET BY LIMITED TRACK RECORD, RAPID LOAN GROWTH AND EXECUTION RISK

TSB was specifically designed to become a challenger bank after the European Commission required LBG to divest part of its retail business in 2009. Since European and UK authorities wanted TSB to have very strong foundations, the bank received a high quality mortgage portfolio from LBG when it was created. According to our calculations, TSB's problem loan ratio as of December 2014 was 0.9%, down from 1.2% as of December 2013.

However, TSB plans a rapid expansion of its loan portfolio over the next five years to close the gap between the scale of its infrastructure -- it is the UK's seventh largest bank in terms of branches -- and the size of its balance sheet, the latter placing the bank in twelfth position among rated UK banks. Although the bank benefits from a favourable operating environment in the UK with expected low unemployment and relatively solid economic growth, Moody's believes that competition will continue to increase among UK lenders. This will make achieving growth targets more difficult and could lead to a relaxation in underwriting standards, resulting in greater downside risk, a credit negative in Moody's view.

As a mortgage lender, the bank currently has a very granular lending portfolio with no particular borrower concentrations and a very low average loan-to-value ratio of 41.5%. This includes the 'Mortgage Enhancement' portfolio received from LBG which is expected to boost profitability, although it is subject to a call option once it generates GBP230 million in profits. Nonetheless, the overall mortgage portfolio gives the bank material protection under adverse economic circumstances.

Due to the recent establishment of TSB as an independent entity outside of LBG, TSB's through-the-cycle performance has not yet been demonstrated. As a relatively new independent bank now facing a transition process to become a subsidiary of Banco Sabadell S.A, (Baa3/Ba1 stable, ba3), a new entrant into the UK market, TSB will face a high level of operational risk and potentially high execution risk in migrating into the IT platform of its new parent. Despite Banco Sabadell's track record of successfully integrating acquired banks into its IT platform, there is always uncertainty around the timing, costs and effect on customers and employees of such a transition. Offsetting these integration related risks, however, Moody's notes positively the protection from losses arising from legacy misconduct or litigation as covered under an indemnity provided by LBG. This limits significantly the downside risk arising from potential fines or legal settlements, giving the bank a financial advantage compared to peers.

Moody's also believes that TSB's management team will face significant challenges, given both the relatively short history of the bank and the tasks they will face in integrating with a new parent from a cultural point of view and potentially from an operational perspective.

In summary, the bank has a high quality loan portfolio but has a limited track record and faces significant challenges due to its expansion plans and the change in control. Moody's assigns a baa3 Asset Risk score to reflect all these factors.

SOLID CAPITAL AND LEVERAGE METRICS PROTECT THE BANK AGAINST DOWNSIDE RISK

TSB's tangible common equity (TCE) to risk-weighted assets (RWAs) stood at 23.6% as of December 2014. However, the pro forma ratio reflecting the changes in the method to calculate its RWAs for credit cards, overdrafts and business banking from a Standardised to an Internal Ratings-Base basis, shows a decline by approximately 270 basis points to 20.9%. Moody's believes that despite this material difference, the ratio remains high and provides the bank with sufficient capital to absorb unexpected losses and support growth ambitions. The bank's leverage ratio is also strong and relatively high compared to UK peers, at 5.8% as of December 2014.

On both a current and forward looking basis, Moody's sees capital as one of TSB's main strengths and this results in a score of aa3. This score, incorporates TSB's presently strong capital metrics, but also our expectation that capital and leverage ratios will decline as the bank increases its lending. It also incorporates the results of our stress test, as the expected levels of profitability under an adverse scenario would trigger a significant decline in the regulatory capital ratio. However, even under this scenario, using its current portfolio composition, the bank would remain well above regulatory minimums.

EXPECTED LOW LEVELS OF PROFITABILITY, GIVEN HIGH COST BASE

Moody's considers that the main challenge for TSB is to improve its profitability levels. TSB has a very large cost base due to its large branch network, which compares unfavourably with the relatively small size of its asset base. According to Moody's calculations, TSB's cost-to-income ratio was 77.3% as of December 2014. Despite the GBP230 million total profit that TSB will likely receive from the mortgage enhancement portfolio provided by LBG and the GBP450 million contribution from LBG to compensate the bank for the implementation costs of IT migration, profitability will likely remain under pressure until the bank is able to increase the size of its credit portfolio or reduce its cost base. Since profitability is a relative weakness and is not expected to remediate for a number of years, Moody's assigns a score of b1, two notches below the bank's macro-adjusted score.

LOW RELIANCE ON WHOLESALE FUNDING AND GRANULAR DEPOSIT BASE

In addition to capital, Moody's considers TSB's funding profile as a strength. The bank's liability structure has been designed with spare capacity for growth, including a significant amount of excess deposits and a very low reliance on wholesale funding. According to Moody's calculations, market funds as a proportion of tangible banking assets was 1.2% as of December 2014. Moody's understands that the bank would like to increase the size of its loan book faster than the size of its deposit balances to improve profitability. Although the bank also plans to increase the proportion of wholesale funds on its balance sheet, Moody's believes that these will remain at a relatively low level and therefore assigns an aa2 score to TSB's Funding Structure.

ADEQUATE LIQUIDITY BUFFERS

Moody's believes that the bank has adequate liquidity buffers. According to Moody's calculations, the bank's liquid assets as a proportion of its tangible banking assets, stood at 18.4% as of December 2014. The rating agency expects this ratio to show only a slight decline as the bank uses some of this liquidity to expand its loan portfolio. However, the bank could also maintain an increasing amount of additional liquidity in the form of securitized bonds. As a result, Moody's assigns a baa3 score to reflect these factors.

In aggregate, Moody's assigns a Financial Profile of baa1 to TSB.

Given that TSB's business activity will be initially limited to retail banking operations, this relatively narrow focus results in Moody's including a one-notch negative qualitative adjustment in respect of business diversification resulting in a BCA of baa2.

At the moment TSB's BCA at baa2 exceeds the standalone rating of its parent Banco Sabadell by four notches. This differential reflects the very limited connections between the two institutions. Moody's expects that over time increasing operational linkages are likely to develop between the two institutions, which could affect TSB's stability in the event its parent faces financial or operational challenges. Therefore the current four-notch differential could narrow as the IT migration plans are completed or Banco Sabadell's BCA improves before TSB is able to build a stronger track record.

LONG-TERM DEPOSIT RATINGS

TSB is domiciled in the UK, a jurisdiction which is subject to the EU Bank Resolution and Recovery Directive (BRRD), which Moody's considers to be 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 TSB and most mortgage lenders in the UK, Moody's assumes the proportion of deposits considered junior at 10%, relative to the standard assumption of 26%, due to their largely retail-oriented deposit base.

Our Advanced loss-given failure (LGF) analysis indicates that TSB's deposits and senior unsecured debt are likely to face moderate loss-given-failure, due to the loss-absorption provided by the dated subordinated debt issued by the holding company, TSB Banking Group, as well as the volume of deposits themselves. This results in a Preliminary Rating Assessment for TSB's deposits and potentially for senior unsecured debt at the same level as the bank BCA at baa2. The positive outlook reflects TSB's funding plans, which will likely involve the issue of senior unsecured debt at the holding company, which would provide additional protection to depositors and creditors of the operating entity.

TSB Banking Group's senior unsecured and subordinated instruments are likely to face a high loss-given-failure according to our LGF analysis given the relatively small volume of existing debt and very limited protection from more subordinated instruments and residual equity. As a result, we assign an issuer rating of Baa3 to TSB Banking Group and a Baa3 rating to its existing tier 2 dated subordinated bonds.

WHAT COULD MOVE THE RATING -- UP/DOWN

An upgrade in the bank's deposits and issuer ratings of the operating company could be triggered by the issue of senior or subordinated debt instruments at the holding company, which would provide protection to depositors and creditors. An upgrade in the BCA driven by a longer track record, reduced execution risk and improved levels of profitability could also lead to an upgrade of all ratings. Any such movement in TSB's BCA would however continue to be constrained by the BCA of Banco Sabadell.

Conversely, a downgrade of TSB's rating could be driven by a deterioration in the bank's asset quality, which could in turn pressure capital. Sizable losses or successive periods of low/negative profits due to failure to achieve a low cost base while increasing revenues would also put pressure on the ratings. Negative pressure could also arise from higher than expected deterioration in the bank's liquidity and profitability metrics. Any increasing linkages between TSB and its parent, could also lead to a reassessment of the rating relative to the ratings of Banco Sabadell. In the absence of an upgrade of Banco Sabadell's BCA, this situation could result in negative rating pressure for the bank's ratings.

LIST OF ASSIGNED RATINGS

TSB Bank plc

- Long-Term Local Currency deposit rating: Baa2; Outlook Positive

- Short-Term Local Currency deposit rating: Prime-2

- Long-Term Local Currency issuer rating: Baa2; Outlook Positive

- Baseline Credit Assessment: baa2

- Adjusted Baseline Credit Assessment: baa2

- Counterparty Risk Assessment: A2(cr)/Prime-1(cr)

TSB Banking Group plc

- Long-Term Local Currency issuer rating: Baa3; Outlook Stable

- Subordinate rating: Baa3

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Banks published in March 2015. Please see the Credit Policy 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 rating action on the support provider and in relation to each particular 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 rating action, and whose ratings may change as a result of this 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.

The following information supplements Disclosure 10 ("Information Relating to Conflicts of Interest as required by Paragraph (a)(1)(ii)(J) of SEC Rule 17g-7") in the regulatory disclosures made at the ratings tab on the issuer/entity page on www.moodys.com for each credit rating as indicated:

Moody's was not paid for services other than determining a credit rating in the most recently ended fiscal year by the person(s) that paid Moody's to determine this credit rating.

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.

Carlos Suarez Duarte
Vice President - Senior Analyst
Financial Institutions Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454

Nicholas Hill
Managing Director
Financial Institutions Group
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 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
SUBSCRIBERS: 44 20 7772 5454

Moody's assigns Baa2/P-2 ratings to TSB Bank plc and Baa3 ratings to TSB Banking Group plc
No Related Data.
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