C- Bank Financial Strength rating outlook to stable from negative; Aa3 debt/ deposit ratings affirmed; subordinated debt and certain hybrid instruments upgraded
London, 13 September 2010 -- Moody's has changed the outlook on Lloyds TSB plc's C-
standalone Bank Financial Strength Rating (BFSR) to stable from negative
and affirmed the Aa3 senior debt and deposit ratings, which already
had a stable outlook. The P-1 short-term rating was
also affirmed. The C- Financial Strength Rating now maps
to a standalone rating of Baa1 on the long-term scale, upgraded
from the previous mapping of Baa2. The change in outlook and higher
standalone rating is based on the stabilisation that is taking place in
the financial profile of Lloyds Banking Group (LBG), and a reduced
likelihood of the rating moving lower over the medium term.
The outlook on the D+ BFSR (mapping to a standalone rating of Baa3)
of Bank of Scotland plc was also changed to stable from negative.
Subordinated debt and certain hybrid ratings of the group (the "Must
Pay" securities that are not required by the European Commission
to skip coupons) were upgraded by one notch and the outlook changed to
stable, in line with the change in the standalone rating.
The "May Pay" securities that are required by the European
Commission to skip coupons and the Enhanced Capital Notes (ECNs) were
affirmed at their current level and the outlook changed to stable.
The A1 senior debt ratings of Lloyds Banking Group (LBG) and HBOS,
were affirmed. Moody's also affirmed and revised the outlooks
to stable from negative for Baa1-rated subordinated debts at Clerical
Medical and Scottish Widows plc.
RATINGS RATIONALE
RATIONALE FOR CHANGE OF FINANCIAL STRENGTH OUTLOOK
Since the last rating action in November 2009 when the Bank Financial
Strength Rating was lowered to C- with a negative outlook following
Lloyds' capital raising and decision not to participate in the UK
government's Asset Protection Scheme, some notable improvements
have become visible:
- ongoing deleveraging, including a reduction in non-core
assets by GBP 87 billion,
- strengthened liquidity reserves, from GBP 105 billion at
the end of 2008 to GBP 128 billion at the end of H110
- further progress in the integration of HBOS, including
GBP 1.08bn of realised annualised cost savings as of H110
- indications that the earlier high level of impairments have peaked,
with impairments of GBP 6.6bn in H110, compared to GBP 13.4bn
in H109
- increase in Net Interest Margin from 1.72% in H109
to 2.08% in H110 against an environment of margin compression
among many smaller banks and building societies in the UK
Moody's still considers that the profitability of UK banks will
come under pressure from elevated impairments over 2010- 2011,
despite early indications that they may be past the peak. The pressure
may come particularly from areas such as consumer finance -- which
is vulnerable to an increase in unemployment, or SME lending --
where small businesses may struggle to maintain cashflows even as the
economy recovers.
However, the rating agency considers that further loan impairments
at LBG can be absorbed at the bank's C- Bank Financial Strength
Rating level. In particular, given the high level of impairments
already taken on the bank's riskier commercial property assets,
Moody's views LBG as able to withstand Moody's severe stress
test without a need for further capital support.
Nevertheless, the C- Bank Financial Strength Rating also
incorporates the many challenges facing the bank:
- the ongoing wind-down of the remaining large portfolio
of Non-Core assets (GBP 217bn at H110)
- the reduction in the bank's high utilisation of wholesale
funding, including government funding of GBP 120 billion at the
end of H110 -- much of which matures in 2011, but which will
partly be resolved by the wind-down of non-core assets mentioned
above
- the completion of a complex integration, particularly the
integration of IT systems which is scheduled to take place in 2011
- the sale of a portion of the bank's UK franchise due to
EC requirements (likely to take place in 2012 after the integration is
completed)
- the ongoing reduction of a large sectoral exposure to commercial
real estate
Alongside these challenges is the risk of a further downturn in the UK
economy.
"With the measures that Lloyds has been taking to strengthen the
bank, its standalone credit strength is well captured at the standalone
rating level of Baa1 with limited downside risks", said Elisabeth
Rudman, a Senior Credit Officer at Moody's and lead analyst
for LBG. "Steady progress in the integration of HBOS,
as well as a further meaningful reduction of non-core assets and
in the high level of wholesale financing, could lead to upward pressure
on the standalone rating" Rudman continued. Whereas high
levels of impairment losses or management actions which lead to a reduction
in capital ratios from their current strong levels could lead to negative
pressure on the standalone rating.
RATIONALE FOR AFFIRMED Aa3 SENIOR DEBT RATING, STABLE OUTLOOK
The Aa3 senior debt rating with a stable outlook for LTSB continues to
incorporate our expectation of high support by the UK government.
(Please also refer to the Special Comment "Phasing Out Extraordinary
Support Assumptions from UK Bank Ratings" published in March 2009,
for further information on our views on systemic support for UK banks).
Despite EC requirements for LBG to dispose of 600 branches and 4.6%
market share of the personal current account market in the UK and approximately
19% of the group's mortgage assets by November 2013,
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.
Although we expect with time to phase out the levels of extraordinary
support incorporated in the ratings of banks such as Lloyds (which has
4 notches of uplift from the Bank Financial Strength Rating to the senior
debt ratings), an important factor in our assessment will be the
outcome of further government actions, including the government-sponsored
commission to review the structure of the banking system, the development
of living wills, and the timing of the sale of the government's
shareholding in LBG.
OUTLOOK ON BANK OF SCOTLAND D+ FINANCIAL STRENGTH RATING CHANGED
FROM NEGATIVE TO STABLE
The change in outlook of Bank of Scotland's D+ Bank Financial
Strength Rating (which maps to Baa3 on the long-term debt rating
scale) reflects the fact that LBG is proactively winding down some of
the riskiest assets within Bank of Scotland (BoS), as well as increasing
integration of Bank of Scotland/ HBOS within LBG. Nevertheless,
the standalone financial strength rating still remains lower at BoS than
at Lloyds TSB (whose BFSR represents the standalone financial strength
of the combined group), due to the higher concentration of weaker
assets and slightly lower capital ratios (Tier 1 ratio of 7.6%
at BoS at H110 and 9.4% at HBOS, compared to 10.3%
at LBG). However, as we move closer to the full integration
of BoS/ HBOS within LBG, we would expect its standalone ratings
to be aligned with Lloyds TSB.
UPGRADE OF DATED SUBORDINATED AND "MUST PAY" HYBRID SECURITIES,
AFFIRMATION OF "MAY PAY" HYBRID SECURITIES AND ECNS
The dated subordinated and hybrid securities of Lloyds Banking Group,
which are not required by the European Commission to skip coupon payments
("Must Pay" securities), have been upgraded by 1 notch
and the outlook changed from negative to stable. This is in line
with the upgrade in the mapping of the financial strength rating from
Baa2 to Baa1. Consequently the dated subordinated debt of Lloyds
TSB and Bank of Scotland is upgraded from Baa3 to Baa2, and the
dated subordinated debt of Lloyds Banking Group and HBOS is upgraded from
Ba1 to Baa3. For more information on the hybrid securities and
their ISINs, please refer to Moody's press release of 23rd
November ("Moody's concludes rating action on Lloyds hybrid
and junior subordinated debt").
The hybrid securities of Lloyds Banking Group that are skipping coupon
payments in line with EC requirements ("May Pay" securities)
and are rated on an expected loss basis have been affirmed at their current
level and the outlook changed from negative to stable.
The Enhanced Capital Notes, the dated non-deferrable Contingent
Capital Instruments which convert to equity if the group's Core
Tier 1 ratio drops below 5%, have been affirmed at their
current level (Ba2 for notes guaranteed by Lloyds TSB and Ba3 for notes
guaranteed by Lloyds Banking Group) and the outlook changed from negative
to stable. The rating of these instruments reflects the high loss
severity to investors in the event of conversion and the lack of transparency
of the trigger due to influence of the regulator on the calculation of
RWAs. The ratings of these instruments is not likely to move higher
if the bank's standalone rating is upgraded.
OUTLOOK ON INSURANCE SUBORDINATED DEBTS CHANGED TO STABLE
Moody's also affirmed and revised the outlooks to stable from negative
for Baa1-rated subordinated debts at Clerical Medical and Scottish
Widows plc.
Moody's said that the revision to stable from negative for the subordinated
debts at Lloyds TSB's insurance operations (Scottish Widows plc
and Clerical Medical) reflected the ongoing stability of the insurance
operations -- Aa3 and A1 IFSR, stable outlook, respectively
-- as well as the upgrade and stable outlook for subordinated securities
at Lloyds TSB Bank and Bank of Scotland. Moody's added that
the insurance subordinated debt continues to be rated higher than the
subordinated debt of both Lloyds TSB Bank and Bank of Scotland by one
notch and two notches respectively. This reflects Moody's expectations
that the solvency positions of both Scottish Widows and Clerical Medical
will continue to be robust going forward . Nevertheless,
whilst we believe the capital of the insurance operations remains partially
protected, the insurance subordinated debts continue to be notched
wider than Moody's standard notching for insurers, reflecting Moody's
view that Lloyds Banking Group's capital base is increasingly managed
centrally.
PREVIOUS RATING ACTION AND METHODOLOGY
The principal methodologies used in rating Lloyds Banking Group were Bank
Financial Strength Ratings: Global Methodology published in February
2007, and Incorporation of Joint-Default Analysis into Moody's
Bank Ratings: A Refined Methodology published in March 2007.
Other methodologies and factors that may have been considered in the process
of rating this issuer can also be found on Moody's website.
The last rating action on the group was 23rd November 2009, when
we concluded the reviews on hybrid securities. The last announcement
on the bank's BFSR was on 3 November 2009 when the BFSR was downgraded
to C- with a negative outlook.
Lloyds Banking Group is based in the United Kingdom, and had total
assets of GBP 1,028 billion at 30 June 2010.
REGULATORY DISCLOSURES
Information sources used to prepare the credit rating are the following:
parties involved in the ratings, public information, confidential
and proprietary Moody's Investors Service's information.
Moody's Investors Service considers the quality of information available
on the issuer or obligation satisfactory for the purposes of maintaining
a credit rating.
The rating has been disclosed to the rated entity or its designated agents
and issued with no amendment resulting from that disclosure.
Moody's Investors Service may have provided Ancillary or Other Permissible
Service(s) to the rated entity or its related third parties within the
three years preceding the Credit Rating Action. Please see the
ratings disclosure page www.moodys.com/disclosures on our
website for further information.
MOODY'S adopts all necessary measures so that the information it uses
in assigning a credit rating is of sufficient quality and from sources
MOODY'S considers to be reliable including, when appropriate,
independent third-party sources. However, MOODY'S
is not an auditor and cannot in every instance independently verify or
validate information received in the rating process.
Please see ratings tab on the issuer/entity page on Moodys.com
for the last rating action and the rating history.
The date on which some Credit Ratings were first released goes back to
a time before Moody's Investors Service's Credit Ratings were fully digitized
and accurate data may not be available. Consequently, Moody's
Investors Service provides a date that it believes is the most reliable
and accurate based on the information that is available to it.
Please see the ratings disclosure page on our website www.moodys.com
for further information.
Please see the Credit Policy page on Moodys.com for the methodologies
used in determining ratings, further information on the meaning
of each rating category and the definition of default and recovery.
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
MD - Banking
Financial Institutions Group
Moody's Investors Service Ltd.
JOURNALISTS: 44 20 7772 5456
SUBSCRIBERS: 44 20 7772 5454
Moody's Investors Service Ltd.
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Moody's changes Lloyds financial strength outlook to stable from negative
