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Rating Action:

Moody's reviews Lloyds TSB and HBOS for possible downgrade

18 Sep 2008
Moody's reviews Lloyds TSB and HBOS for possible downgrade

London, 18 September 2008 -- Moody's Investors Service today announced that it had placed the BFSR and long-term ratings of both Lloyds TSB and HBOS and their associated subsidiaries on review for possible downgrade. The rating action follows the announcement that the entities are planning a merger.

The B+ financial strength rating of Lloyds TSB Bank plc along with its Aaa senior debt and long-term deposit ratings, as well as the Aa1 senior debt rating for Lloyds TSB Group were all placed on review for possible downgrade.

The B financial strength rating of Bank of Scotland plc along with its Aa1 senior debt and long-term deposit ratings, as well as the Aa2 debt rating for HBOS plc (the holding company for Bank of Scotland) were all placed on review for possible downgrade. The ratings of HBOS and its banking operations were already on negative outlook following the announcement in April that the group had taken substantial negative fair value adjustments and reflecting the vulnerability of the bank to the deteriorating economic environment in the UK.

The Prime-1 short term ratings of both banks were affirmed.

The merger would create the largest retail financial services group in the UK, whose entities had combined assets of over GBP1 trillion at the end of June 2008. The enlarged group estimates it will have a leading position in core retail financial products and in household insurance and bancassurance, and be the third-largest player in mid-market commercial banking.

However, Moody's considers the merger of two large financial institutions, which poses significant integration risks, will face additional challenges given the difficult conditions in the global financial markets and the deteriorating economic environment in the UK.

The review will focus on the following:

- Capital strength of the enlarged group and assumptions for future capital levels. In this respect, Moody's considers it a positive development that the final dividend for the enlarged group I 2008 will be paid in shares and that Lloyds TSB will subtract HBOS' negative fair value adjustments in the AFS reserve from its capital calculations.

- Cost and revenue synergies: Moody's believes that the considerable duplication across the two organisations offers significant potential cost synergies, however implementing cost reductions and reducing balance sheet exposures could have negative repercussions for the firm's reputation in the current weak economic environment

- Quality of the joint loan books and vulnerability to the deteriorating economic environment in the UK. Moody's said that it will consider the on-going robustness of the commercial property loan book of both firms, given the rapid decline in property values. With regards to residential mortgages, Moody's noted that Lloyds TSB's mortgage book (the Cheltenham and Gloucester brand) has a conservative profile with impairment charges still low at 0.09% of average mortgage lending in H108. In contrast, the rating agency said that HBOS' mortgage book contains a substantial element of specialist mortgage lending (28% of the group's mortgage portfolio, and around 15% of the group's overall loan portfolio) and arrears across both the standard and specialists books have deteriorated.

- Funding profile of the enlarged group

- HBOS' structured securities portfolio and the extent to which a further deterioration in market conditions could lead to additional substantial negative fair value adjustments (particularly given the potential for further stress on market prices following the Lehman bankruptcy).

- The legal structure of the group and its subsidiaries post-merger

Moody's noted that the merger is subject to regulatory and shareholder approval, but considers that it is extremely likely to go ahead, and is expected to be finalised by end 2008/early 2009.

Moody's also placed under review for possible downgrade the Aa2 Insurance Financial Strength Rating ("IFSR") and A1 subordinated debt ratings of the Clerical Medical Investment Group Limited as well as the Aa1 IFSR and Aa3 subordinated debt ratings of Scottish Widows plc, reflecting the companies' ownership and expected level of support.

The Aa2 deposit rating of Lloyds TSB Offshore Ltd was also placed on review for possible downgrade, in line with the action on Lloyds TSB Bank plc.

The Aa3 deposit rating of Bank of Scotland (Ireland) was also placed on review for possible downgrade, in line with the action on its parent, as was the Aa3 deposit rating of Bank of Western Australia Ltd

At the end of June 2008 Lloyds had total assets of GBP368 billion and HBOS total assets of GBP681 billion. Lloyds is headquarted in London and HBOS in Edinburgh.

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

No Related Data.
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