London, 16 February 2009 -- Moody's Investors Service today downgraded the long-term bank deposit
and senior debt ratings of Lloyds TSB Bank plc (LTSB) to Aa3 from Aaa
and the senior debt rating of Lloyds Banking Group plc (Lloyds) to A1
from Aa1. The debt ratings have a stable outlook. The bank
financial strength rating (BFSR) of LTSB was downgraded to C+ (mapping
to a baseline credit assessment (BCA) of A2) from B+ (a BCA of Aa2),
with a negative outlook. The Prime-1 ratings on the short-term
obligations of all the group entities (including HBOS entities) were affirmed.
The long-term bank deposit and senior debt ratings of Bank of Scotland
plc were downgraded from Aa1 to Aa3, the same level as LTSB,
and the senior debt rating of HBOS plc (HBOS) was downgraded from Aa2
to A1, the same level as Lloyds Banking Group plc. The BFSR
of Bank of Scotland was downgraded to C- (mapping to a BCA of Baa2)
from B (BCA of Aa3), and remains under review for further possible
downgrade.
The ratings assigned to LTSB and Bank of Scotland reflect Moody's
view of the overall financial profile of Lloyds following its acquisition
of HBOS which closed on 19 January 2009. "The downgrades
reflect the high level of troubled and higher risk exposures within HBOS
which Moody's considers will weaken the profitability and capital adequacy
of the overall group, as well as the very significant operational
challenge of integrating a larger and weaker bank into the group,"
explains Elisabeth Rudman, Vice President -- Senior Credit
Officer in Moody's Financial Institutions Group.
The acquisition of HBOS by Lloyds means that the group is now the dominant
retail bank in the UK, with market-leading positions in current
accounts, savings accounts, residential mortgages, credit
cards and unsecured lending. The combined entity will also have
the second-largest market share in business banking, behind
Royal Bank of Scotland. Although this expanded franchise should
enable the group to continue to generate substantial pre-provision
earnings, the acquisition brings with it significant challenges.
Specifically, Moody's notes that integrating a group of the
size of HBOS (total assets at end-June 2008 of GBP681 billion compared
with the GBP368 billion of Lloyds) during a major market downturn may
prove problematic and will be a substantial challenge for the management
team.
In addition, given the difficult environment, we believe that
the forecasted cost savings may take longer to generate than would otherwise
have been the case. A positive factor for HBOS however is the introduction
of Lloyds's lower risk appetite into the franchise of HBOS.
However, given the size of HBOS's loan book, this will
not be reflected in the group's asset quality indicators for some
time.
DOWNGRADE OF LTSB BFSR TO C+ AND BANK OF SCOTLAND BFSR TO C-
The downgrade to C+ and negative outlook on LTSB's BFSR reflects
the substantially higher risk taken on by the group as a result of the
acquisition of HBOS, as well as the continuing difficult environment
in the UK. And the downgrade to C- (under review for further
possible downgrade) of Bank of Scotland's BFSR reflects the high
proportion of troubled assets remaining within this entity.
Moody's recognises that the recent capital injections into the group
from the UK government of GBP17 billion provide the combined entity with
a substantially larger capital base. Lloyds has recently indicated
that the group's pro-forma core Tier 1 capital ratio at the
end of 2008 will be within the range of 6.0 -- 6.5%
and Tier 1 ratio over 9%, taking into account the capital
raisings and initial fair value analysis, as well as an expected
GBP10bn pre-tax loss at HBOS in 2008.
However, Moody's expects further writedowns will still need
to be taken on Bank of Scotland`s Alt-A portfolio, due to
the ongoing deterioration in these securities, as well as further
substantial impairment charges on the Bank of Scotland's commercial
property and approximately GBP 30 billion book of self-certified
residential mortgages. Morevoer, Moody's does not allow
for any benefit for gains through the fair value of own debt of HBOS.
Moody's considers LTSB's loan books to be more conservatively
positioned than HBOS', with relatively low loan-to-value
ratios (LTVs) on residential mortgage and commercial property lending.
However, impairments on the bank's approximately GBP20bn SME
lending and GBP24bn retail unsecured lending, are likely to increase
due to the depth of the recession in the UK and rapid growth in unemployment,
which is reflected in Moody's negative outlook for credit conditions
in the UK banking sector. Moody's central risk scenario for
the UK economy is outright contraction followed by a mild rebound in 2010
and unemployment of 7% -- 8% on average.
"In Moody's opinion, all of the above charges will continue
to have a negative impact on the profitability and capitalisation of Lloyds.
At the bank's current BFSR of C+ we consider the tolerance
for further impairment charges and losses to be around GBP16 billion (beyond
what the bank has already indicated is expected to be reported by Lloyds
and HBOS in 2008). Losses above this level would increase the downward
rating pressure on the BFSR of Lloyds TSB and Bank of Scotland",
says Ms. Rudman.
In addition, Moody`s notes that the government's announced
Asset Protection Scheme could cap or reduce some losses, which could
have a material impact on the financial profile of Bank of Scotland in
particular. Therefore, the rating agency has left the Bank
of Scotland's BFSR under review for further possible downgrade in
order to assess the impact of this programme. Should the government's
plan not have a material impact on limiting the bank's future losses,
the BFSR is likely to be downgraded further.
DOWNGRADE OF SENIOR RATINGS TO Aa3 FROM Aaa
The downgrade of LTSB's long-term bank deposit and senior
debt ratings to Aa3 reflects the weaker intrinsic financial strength of
the group, as indicated by the C+ BFSR. However,
given the combined group's position as the largest retail and commercial
bank in the UK and the government's 43% stake, Moody's
continues to assess the probability of systemic support for the group
in the event of need as very high, which leads to a two-notch
uplift for the deposit and debt ratings from the A2 BCA.
Moody's notes that, as a result of the acquisition,
HBOS and its subsidiaries have become subsidiaries of Lloyds, rather
than being merged into LTSB. Lloyds has also not guaranteed or
assumed any outstanding debt of HBOS or any of its subsidiaries.
However, the equalisation of the debt ratings reflects the strategic
importance of HBOS to Lloyds, and the fact that the businesses will
be managed as one. It also incorporates our expectation that government
support would be available to the combined group without a differentiation
of legacy structures.
Although Moody's base-case scenario is that the government's
stake in Lloyds will not increase further, such a scenario cannot
be ruled out. However, if this were to happen, it would
be unlikely to lead to a substantial change in the long-term ratings.
RATING IMPACT ON SUBSIDIARIES AND OTHER DEBT CLASSES
The subordinated debt and hybrid instruments of LTSB and Bank of Scotland
(the operating banks) were downgraded to A1 and A2, respectively,
and the subordinated debt and hybrid instruments of Lloyds and HBOS were
downgraded to A2 and A3, respectively. The government backed
ratings assigned to the debt instruments of LTSB and BOS, benefiting
from the UK government guarantee, remain rated Aaa.
The following rated banking subsidiaries of the group were also downgraded:
Lloyds TSB Offshore to A1 from Aa2 and Bank of Scotland (Ireland) to A2
from Aa3.
A separate press release will be issued on rating actions related to Scottish
Widows and Clerical Medical and their subsidiaries.
Moody's last rating action on Lloyds was implemented on 18 September
2008 when its ratings were put 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 sub-directory. 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.
At the end of June 2008, Lloyds TSB Group (now renamed Lloyds Banking
Group plc) had total assets of GBP368 billion and HBOS plc, the
parent of Bank of Scotland plc, had total assets of GBP681 billion.
Lloyds Banking Group is headquartered in London.
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 downgrades Lloyds TSB and Bank of Scotland (senior to Aa3)
