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Rating Action:

Moody's downgrades Lloyds TSB Bank to A2; outlook negative

21 Jun 2012

Actions conclude review announced on 15 February 2012

London, 21 June 2012 -- Moody's Investors Service has today downgraded Lloyds TSB Bank plc's senior debt and deposit ratings by one notch to A2 from A1 and lowered the standalone credit assessment to baa2 from baa1 within the C- standalone bank financial strength rating (BFSR) range. The outlook is stable on the C-/baa2 standalone credit assessment and negative on the A2 debt and deposit ratings, reflecting Moody's medium-term view of lower systemic support for large UK banks. The short-term Prime-1 rating was confirmed.

The drivers for the downgrade and weakened standalone credit profile are (i) the bank's sensitivity to the increasingly challenging operating environment in the UK and also in Europe; and (ii) Lloyds' high (albeit declining) use of wholesale funding, which implies that it would be vulnerable to changes in investor sentiment towards European banks.

Several factors mitigate these risks and have limited the extent and scope of today's actions. These include (i) Lloyds' leading UK-based customer franchises; (ii) strong capital ratios; and (iii) a track record of successfully meeting restructuring targets. The latter includes the integration of HBOS and the wind-down of non-core assets, as well as the progress in strengthening the bank's funding and liquidity profile.

The senior debt and deposit ratings incorporate three notches of systemic support, reflecting Moody's expectation of a very high probability of systemic (government) support for the bank. However, the outlook is negative on the A2 debt and deposit ratings, reflecting Moody's medium-term view of lower systemic support for large UK banks.

Please click on this http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_143265 for the List of Affected Credit Ratings. This list is an integral part of this Press Release and identifies each affected issuer.

Today's rating actions conclude Moody's decision to review Lloyds TSB Bank's ratings for downgrade (please see "Moody's reviews ratings for European Banks", 15 February 2012 (http://www.moodys.com/research/Moodys-Reviews-Ratings-for-European-Banks--PR_237914). For additional information on bank ratings, please refer to the webpage containing Moody's related announcements: http://www.moodys.com/bankratings2012.

RATINGS RATIONALE

The downgrade of Lloyds' ratings is principally driven by its sensitivity to an increasingly challenging operating environment in the UK and also in Europe. The bulk of the bank's operations are UK-based; however, the weak macroeconomic outlook in Europe complicates the challenges within the UK economy. Moreover, Moody's considers that Lloyds' high (albeit declining) usage of wholesale funding means the bank is vulnerable to changes in investor sentiment towards European banks. Further challenges include the European Commission's mandated sale of UK branches.

Several factors mitigate these risks. These include (i) Lloyds' leading UK-based customer franchises; (ii) strong capital ratios; and (iii) a track record of successfully meeting restructuring targets. The latter includes the integration of HBOS and the wind-down of non-core assets, as well as the progress in strengthening the bank's funding and liquidity profile.

Lloyds had wholesale funding of GBP231 billion outstanding at the end of Q1 2012, of which 40% was short-term. This has been steadily reducing (wholesale funding was GBP298 billion at the end of 2010), and Moody's understands that Lloyds' management plans to reduce it further. In addition, Lloyds has been increasing its buffer of liquid assets (GBP106 billion primary liquid assets at the end of Q1 2012 and GBP202 billion total liquidity buffer at the end of 2011). Nevertheless, the relatively high proportion of wholesale funding implies that Lloyds is sensitive to investor confidence (the loan-to-deposit ratio for the whole group has been improving, but was still 130% at the end of Q1 2012) . Similarly, the bank continues to make progress in reducing its non-core assets (down to GBP128 billion at the end of Q1 2012 from GBP194 billion at the end of 2010), and the bank has a good track record of managing down these assets. However, Moody's says that until the assets are wound-down further, the bank remains sensitive to a worsening operating environment.

The stable outlook on Lloyds' standalone credit assessment reflects Moody's full incorporation of the funding and asset-quality risks into the bank's BFSR.

WHAT COULD MOVE THE RATINGS DOWN/UP

The current rating level and outlook incorporate a degree of expected further deterioration in the bank's operating environment and the likelihood that changes in investors sentiment could further weaken its standalone credit profile. However, the ratings may decline further if (i) operating conditions in the UK worsen beyond Moody's current expectations; or (ii) funding conditions worsen significantly for an extended period.

Any reduction in the likelihood of systemic support for large UK banks could exert downwards pressure on the Lloyds' ratings.

In the context of Lloyds' strong retail-oriented domestic franchise, over the medium-term, upwards pressure could develop on its standalone rating if it is able to (i) reduce the impact of non-core assets on its profitability and return to stable net income; and (ii) complete the ongoing improvements to its funding profile, by further reducing its use of wholesale funding.

OTHER GROUP RATINGS

The A2 senior debt rating of the holding company was downgraded to A3, in line with Moody's views on the structural subordination of holding companies. The senior debt ratings of Bank of Scotland plc were downgraded to A2 from A1 and the senior debt ratings of HBOS plc were downgraded to A3 from A2.

The deposit rating of Lloyds TSB Offshore Ltd was confirmed at A2, reflecting the highly integrated nature of this subsidiary, which is small but remains an important gatherer of retail deposits for the group. However, the standalone rating of the bank was lowered to C-/ baa2 from C/a3. This reflects Moody's view that the profitability of Lloyds TSB Offshore remains under pressure and that asset quality problems have occurred in the bank's small (but concentrated) loan portfolio. This positions the standalone rating in line with its parent, Lloyds TSB Bank, in recognition of the highly integrated role of this subsidiary.

SUBORDINATED AND HYBRID INSTRUMENTS

The group's junior instruments were downgraded by one notch, in line with the downgrade of the standalone credit assessment, apart from the instruments discussed below.

However, Moody's took a variety of actions on Lloyds' "May-Pay" securities. These are the securities on which Lloyds omitted coupons due to European Commission restrictions following the receipt of state aid over the period 31 January 2010 to 31 January 2012. Lloyds announced its intention to pay arrears of interest on cumulative preferred securities on 19 January 2012 and recommenced payments from 31 January 2012. The ratings of these instruments have now all been moved, such that they are in line with the "Must-Pay" securities, which are rated in line with hybrid notching guidelines.

The ratings of these instruments are listed in the attached excel spreadsheet: http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_143267

In addition, Moody's downgraded by two notches to Ba1 from Baa2 the ratings of six dated subordinated debt issues of Lloyds TSB Bank that include a substitution or variation clause. These instruments were initially rated in line with other dated subordinated debt instruments, but they are now rated one notch lower than other instruments due to the additional risk for investors resulting from Moody's view that there is some uncertainty regarding the type of instrument that can be substituted in a capital event. For more information on Moody's approach to rating such instruments, please refer to the Special Comment "Moody's Approach To Rating Bank Securities With Variation Provisions" published in March 2012. The list of securities affected is included in the excel spreadsheet referenced above.

ENHANCED CAPITAL NOTES

Moody's has downgraded the enhanced capital notes (ECNs) by one notch to Ba3 for the ECNs guaranteed by Lloyds TSB Bank and B1 for the ECNs guaranteed by Lloyds Banking Group. The downgrades reflect the high loss severity to investors in the event of conversion (these instruments have an equity conversion feature, which is triggered if Lloyds TSB Bank's Core Tier 1 ratio drops below 5%).

INSURANCE OPERATIONS

The insurance financial strength ratings (IFSRs) of Scottish Widows plc (Scottish Widows) and Clerical Medical Investment Group Limited (Clerical Medical) were downgraded by one notch to A2 from A1, and the subordinated debt ratings of both insurers were downgraded to Baa2 (hyb) from Baa1 (hyb). The outlook on all these ratings is stable.

The rating action on the insurance operations follows the downgrade of the senior debt rating and the lowering of the standalone credit assessment of Lloyds TSB Bank. Although Scottish Widows and Clerical Medical's IFSRs remain above the Baa2 standalone credit assessment of owner Lloyds TSB Bank, reflecting the insurers' strong UK life market position, diversified distribution channels and good capital levels, the downgrade of the IFSRs reflects Moody's view that their financial strength is constrained by the ownership by Lloyds TSB Bank. The downgrade to Baa2 (hyb) from Baa1 (hyb) on the subordinated debt ratings of Scottish Widows and Clerical Medical follows the downgrade by one notch on the subordinated debt of the parent bank and reflects Moody's view that Lloyds Banking Group's capital base is managed centrally. As a result the Baa2 (hyb) rating on the insurers' subordinated securities is notched wider than the insurance standard two notches from IFSR.

The stable outlook on the IFSRs and subordinated debt ratings is aligned with the stable outlook of Lloyds TSB Bank's C- BFSR.

The methodologies used in these ratings were Bank Financial Strength Ratings: Global Methodology, published in February 2007, and Incorporation of Joint-Default Analysis into Moody's Bank Ratings: Global Methodology, published in March 2012. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

Please click on this link http://www.moodys.com/viewresearchdoc.aspx?docid=PBC_143265 for the List of Affected Credit Ratings. This list is an integral part of this Press Release and provides, for each of the credit ratings covered, Moody's disclosures on the following items:

Person approving the credit rating

Releasing office

For ratings issued on a program, series or category/class of debt, this announcement provides relevant 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 relevant 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 relevant 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.

The ratings have been disclosed to the rated entities or their designated agents and issued with no amendment resulting from that disclosure.

Information sources used to prepare the ratings are the following: parties involved in the ratings, public information, and confidential and proprietary Moody's Investors Service information.

Moody's adopts all necessary measures so that the information it uses in assigning the ratings 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.

Moody's considers the quality of information available on the rated entities, obligations or credits satisfactory for the purposes of issuing these ratings.

Moody's Investors Service may have provided Ancillary or Other Permissible Service(s) to the rated entities or their related third parties within the two years preceding the credit rating action. Please see the special report "Ancillary or other permissible services provided to entities rated by MIS's EU credit rating agencies" on the ratings disclosure page on our website www.moodys.com for further information.

The below contact information is provided for information purposes only. Please see the issuer page on www.moodys.com for Moody's regulatory disclosure of the name of the lead analyst and the office that has issued the credit rating.

The relevant Releasing Office for each rating is identified under the Debt/Tranche List section on the Ratings tab of each issuer/entity page on moodys.com

Please see the ratings disclosure page on www.moodys.com for general disclosure on potential conflicts of interests.

Please see the ratings disclosure page on www.moodys.com for information on (A) MCO's major shareholders (above 5%) and for (B) further information regarding certain affiliations that may exist between directors of MCO and rated entities as well as (C) the names of entities that hold ratings from MIS that have also publicly reported to the SEC an ownership interest in MCO of more than 5%. A member of the board of directors of this rated entity may also be a member of the board of directors of a shareholder of Moody's Corporation; however, Moody's has not independently verified this matter.

Please see Moody's Rating Symbols and Definitions on the Rating Process page on www.moodys.com for further information on the meaning of each rating category and the definition of default and recovery.

Please see ratings tab on the issuer/entity page on www.moodys.com for the last rating action and the rating history.

The date on which some ratings were first released goes back to a time before Moody's ratings were fully digitized and accurate data may not be available. Consequently, Moody's 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 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.

Elisabeth Rudman
Senior Vice President
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

Johannes Wassenberg
MD - Banking
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 downgrades Lloyds TSB Bank to A2; outlook negative
No Related Data.
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