Credit Opinion: Lloyds Bank Plc

Transcription

1 Credit Opinion: Lloyds Bank Plc Global Credit Research - 05 Oct 2014 London, United Kingdom Ratings Category Moody's Rating Outlook Negative(m) Bank Deposits A1/P-1 Bank Financial Strength C- Baseline Credit Assessment baa1 Adjusted Baseline Credit Assessment baa1 Senior Unsecured Subordinate A1 Baa3 Jr Subordinate Pref. Stock Baa3 (hyb) Ba1 (hyb) Commercial Paper P-1 Other Short Term -Dom Curr (P)P-1 Parent: Lloyds Banking Group plc Outlook Negative(m) Senior Unsecured Subordinate MTN A2 (P)Baa3 Pref. Stock Pref. Stock Non-cumulative Ba2 (hyb) Ba2 (hyb) Clerical Medical Investment Group Limited Outlook Insurance Financial Strength Stable A2 Lloyds TSB Bank plc Hong Kong Branch Outlook Commercial Paper No Outlook P-1 Contacts Analyst Phone Carlos Suarez Duarte/London Michael Eberhardt, CFA/London Johannes Wassenberg/London Javier Gayol/London Key Indicators Lloyds Banking Group plc (Consolidated Financials)[1] [2]6-14 [3]12-13 [3]12-12 [3]12-11 [3]12-10 Avg. Total Assets (GBP million) 824, , , , ,184.0[4]-4.1 Total Assets (EUR million) 1,029, ,868.61,095,769.91,132,757.21,136,926.8[4]-2.4 Total Assets (USD million) 1,410,173.51,365,359.31,444,653.81,470,483.01,525,236.8[4]-1.9 Tangible Common Equity (GBP million) 43, , , , ,579.3[4]-3.3 Tangible Common Equity (EUR million) 54, , , , ,861.8[4]-1.6 Tangible Common Equity (USD million) 74, , , , ,624.1[4]-1.1 Net Interest Margin (%) [5]1.2 PPI / Average RWA (%) [6]2.0

2 Net Income / Average RWA (%) [6]1.4 (Market Funds - Liquid Assets) / Total Assets (%) [5]6.2 Core Deposits / Average Gross Loans (%) [5]76.2 Tier 1 Ratio (%) [6]14.6 Tangible Common Equity / RWA (%) [6]16.8 Cost / Income Ratio (%) [5]74.1 Problem Loans / Gross Loans (%) Problem Loans / (Equity + Loan Loss Reserves) [5] [5]59.4 (%) Source: Moody's [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - transitional phase-in; IFRS [3] Basel II; IFRS [4] Compound Annual Growth Rate based on IFRS reporting periods [5] IFRS reporting periods have been used for average calculation [6] Basel III - transitional phase-in & IFRS reporting periods have been used for average calculation Opinion SUMMARY RATING RATIONALE We rate the debt and deposits of Lloyds Bank plc (Lloyds) A1/ Prime-1. These ratings are underpinned by the bank's standalone credit strength (reflected in a baseline credit assessment (BCA) of baa1) and by our assessment of a very high likelihood of government support to senior depositors and bondholders if needed. This support provides three notches of uplift from the bank's baa1 BCA. The senior debt ratings of the group holding company, Lloyds Banking Group plc (LBG), are one notch below those on Lloyds, reflecting the structural subordination of the holding company to its operating subsidiary. Lloyds' BCA reflects the (1) stabilisation of the group's operating model and the group's reduced downside risk following a multi-year restructuring and de-risking plan; (2) improved liquidity and funding metrics; (3) achievement of solid capital and leverage metrics; and (4) improved earnings generation capacity allowing the bank to absorb further credit impairments and conduct related costs within expected levels. The firm's exposure to further payment protection insurance (PPI) provisions, along with other liabilities and conduct remediation charges, which have proven to be difficult to predict and the remaining sizeable run-off portfolio continue, however, to expose the bank to potential downside risk. Rating Drivers - Solid capital and leverage ratios - Leading retail and commercial banking franchise combined with revenue diversification from its bancassurance subsidiaries provide material "shock absorbers" - Conduct remediation costs and potential litigation charges introduce potential earnings volatility - Improved asset quality reduces downside risk arising from legacy portfolio, though run-off book remains sizeable - Liquidity and funding profile has improved, though use of wholesale funding remains high Rating Outlook The outlook on Lloyds' standalone C- bank financial strength rating (BFSR), which is equivalent to a baa1 BCA, is stable and incorporates our expectation of continued stabilisation of the operating environment in the UK. The outlook remains negative on Lloyds' A1 long-term debt and deposit ratings, reflecting our view of a trend toward lower likelihood of systemic support for large UK banks being provided in the event of need, following the expected implementation of a number of regulatory initiatives. These include the proposal for ring-fencing in the UK and further steps towards implementation of an effective recovery and resolution regime in the EU including bail in of senior creditors. The negative outlook on the long-term ratings also takes into account the recent adoption of the Bank Recovery

3 and Resolution Directive (BRRD) regulation in the EU. In particular, this reflects that, with the legislation underlying the new resolution framework now in place and the explicit inclusion of burden-sharing with unsecured creditors as a means of reducing the public cost of bank resolutions, the balance of risk for banks' senior unsecured creditors has shifted to the downside. Although our support assumptions are unchanged for now, the probability has risen that they will be revised downwards to reflect the new framework. For further details, please refer to our Special Comment entitled "Reassessing Systemic Support for EU Banks," published on 29 May What Could Change the Rating - Up Upward pressure on the bank's BCA could develop if Lloyds is able to (1) continue reducing the impact of conduct remediation on its profitability and return to stable net income; (2) complete the ongoing deleveraging of its run-off portfolio, further limiting downside risk and (3) achieve further material increases in its capital and leverage ratios. What Could Change the Rating - Down Downward pressure on Lloyds' BCA could develop from (1) a material deterioration in the UK's operating environment, including a significant deterioration in the housing market; (2) a material reversal in the trend relating to the use of wholesale funding; and (3) sizeable, unexpected conduct remediation charges. Downward pressure on the senior debt and deposit ratings could develop from material regulatory progress in the UK and Europe regarding the implementation of burden-sharing with senior bondholders in the resolution of large financial institutions. DETAILED RATING CONSIDERATIONS The financial data in the following sections is sourced from LBG's financial statements unless otherwise stated. SOLID CAPITAL AND LEVERAGE RATIOS LBG's capital and leverage ratios continue to improve as the bank reduces its risk-weighted assets (RWAs) through disposals, positioning the bank well relative to regulatory requirements. We expect that the group's improved ability to generate earnings will increasingly contribute to further strengthening of its capital levels as the deleveraging process comes to an end. The group's pro forma fully loaded Basel III common equity Tier 1 ratio increased to 10.7% at end-march 2014 from 10.3% at end-december The changes in the capital metrics have been mainly driven by the Group's renewed earnings generation capacity (GBP1.4 billion statutory profit before tax at end-march 2014), the changes to the Group's defined benefit pension schemes and the exchange of GBP5 billion of its outstanding Enhanced Capital Notes (ECNs) for Additional Tier 1 instruments. The bank also reported a pro forma fully loaded Basel III leverage ratio of 4.5%, up from 3.8% as of December 2013 (pro-forma fully loaded CRD IV stood at 4.1%). Even under conservative assumptions regarding on-going conduct related costs, we expect that LBG will be able to maintain and improve its capital and leverage metrics. Lloyds announced that it expects to apply to the Prudential Regulation Authority in H to restart dividend payments, which in our view, would facilitate further reductions in the government stake and provide additional diversification to its shareholder base. LEADING RETAIL AND COMMERCIAL BANKING FRANCHISE PROVIDES MATERIAL "SHOCK ABSORBERS" LBG's leading commercial and retail banking franchise continues to generate significant revenues, providing good quality "shock absorbers" for further credit impairments and conduct related costs. LBG also continues to benefit from the revenue diversification provided by its bancassurance subsidiaries, Scottish Widows and Clerical Medical, which paid GBP2.2 billion in dividends to the group in 2013 and GBP 400 million in the first quarter of However, we expect a lower insurance dividend contribution to the group going forward, given that Scottish Widows transferred a significant amount of excess capital to LBG in LBG will see a reduction in its market share of personal accounts in the UK as it prepares for the disposal process of TSB Bank in 2014, in line with European Commission requirements. TSB has 631 branches, 4.5 million customers and an approximately 4.6% market share of the personal account market in the UK. Nevertheless, we believe that, following the sale of TSB, LBG will continue to maintain its leading position within the UK retail and commercial market. ONGOING CONDUCT REMEDIATION COSTS AND POTENTIAL LITIGATION CHARGES INTRODUCE POTENTIAL EARNINGS VOLATILITY

4 LBG benefited from a sharp 57% decline in impairments related to the same period the previous year and a 10% increase in net interest income (resulting in a pre-tax statutory profit of GBP1.4 billion for the three months of 2014), reflecting our view of the positive contribution the group's revenue generation capacity will provide against additional conduct remediation costs. In 2013, the group reported approximately GBP3 billion of additional provisions related to mis-selling PPI. While no additional conduct charges took place during the first quarter of 2014, we believe that Lloyds will remain exposed to potential further PPI provisions and other liabilities and charges, including an open matter with Her Majesty's Revenue and Customs and various regulatory investigations. Although the number of customer-initiated complaints regarding PPI continue to decline, proactive mailings from past business reviews and high administrative costs have meant that the average PPI cost per month has not followed the same trend. In addition, Lloyds set aside a further provision of GBP130 million in 2013 related to the sales of interest-rate hedging products to certain small and medium-sized businesses. IMPROVED ASSET QUALITY REDUCES DOWNSIDE RISK ARISING FROM LEGACY PORTFOLIO, THOUGH RUN-OFF PORTFOLIO REMAINS SIZEABLE LBG's asset quality continues to improve, and we believe that the UK's favourable operating environment and lowinterest rate environment will contribute to further improvements in the group's asset quality ratios. The bank's reported problem loan ratio (Impaired loans as a percentage of total loans) declined to 5.7% at the end of March 2014 from 6.3% at end-december Improvements in asset quality metrics have resulted from not only the sale of non-core portfolios, but also the drop in core impaired loans to GBP11 billion in 2013 from GBP13 billion in We expect the group's asset quality to continue to improve, and view positively the high coverage of its Irish commercial and residential property portfolios. LBG decided to reabsorb approximately 31 billion of retail non-core assets including UK (GBP26 billion) and Dutch (GBP5 billion) mortgage portfolios and the majority of the UK Asset Finance business into the core business, with the remaining GBP33 billion portfolio managed in a separate run-off unit. The run-off portfolio, which has been reduced to GBP29.7 billion at end-march 2014, mainly consists of non-core non-retail assets such as commercial real estate and retail assets in other countries such as Ireland and Hong Kong. Although we believe that the downside risk posed by these assets has dramatically declined, unexpected changes in the valuation of UK commercial real estate assets and of other corporate assets still pose some downside risk to the group. LIQUIDITY AND FUNDING PROFILE HAS IMPROVED, THOUGH USE OF WHOLESALE FUNDING REMAINS HIGH The group's funding position has improved as the loan-to-deposit ratio, as reported by the group, declined to 111% at end-march 2014 from 113% in Funding requirements continue to decline in line with the reduction in the size of the bank's non-core portfolio. Total wholesale funding declined to GBP130 as of 31 March 2014 from GBP138 billion as of December 2013, an additional 6% reduction relative to the 19% reduction achieved in During the same period, short-term wholesale funding with a maturity of less than one year declined by an additional 5% to GBP42 billion relative to the 13% drop in According to our calculations, primary liquid assets account for more than twice the firm's short-term wholesale funding. Lloyds does not report any estimates of its liquidity coverage ratio; however, the group says that it expects to meet the minimum requirements that the regulator has imposed ahead of the implementation dates. Global Local Currency Deposit Rating (Joint Default Analysis) Lloyds is the largest retail and commercial bank in the UK. Given this, we attribute a high probability of systemic support to the group, resulting in a three-notch uplift for Lloyds' A1 deposit and debt ratings from the baa1 BCA. LBG's senior debt ratings are one notch below Lloyds's senior debt ratings, owing to structural subordination. Notching Considerations LBG's lower Tier 2 enhanced capital notes (ECNs) issued by LBG Capital No1 plc and LBG Capital No2 plc are rated Ba2 (hyb) and Ba1 (hyb), respectively. The ratings are in line with our May 2013 revised global banks methodology for rating bank hybrid securities, contractual non-viability securities (a type of contingent capital security), and subordinated debt. The relevant ECNs issued by LBG are dated subordinated debt containing a conversion trigger to ordinary shares in whole (and not in part) that occurs if LBG's consolidated core Tier 1 ratio is lower than 5%. However, a significant proportion of the ECNs were exchanged (GBP5 billion) into Additional Tier 1 (GBP5.35 billion). In positioning the securities one notch lower than "plain vanilla" subordinated debt, the ratings incorporate the uncertainty surrounding the timing of equity conversion. The rating on the ECNs issued by LBG Capital No1 is

5 positioned two notches below the adjusted BCA, in line with our standard notching guidance for contractual nonviability subordinated debt. The ECNs issued by LBG Capital No1 plc, guaranteed by LBG (A3 negative), are rated one notch lower than the ECNs issued by LBG Capital No2 plc, guaranteed by Lloyds Bank (deposits A1 negative, bank financial strength rating C-/baseline credit assessment baa1 stable), reflecting the structural subordination of the holding company (LBG) to its operating subsidiary. The ratings on the subordinated debt issued by Lloyds, with a substitution clause, are two notches below the adjusted BCA, reflecting the uncertainty linked to the substitution clause. The ratings on the remaining subordinated capital instruments of LBG are linked to the BCA of the bank (adjusted to incorporate one notch structural subordination for the holding company). The "plain vanilla" subordinated debt instruments are one notch below the adjusted BCA; junior subordinated instruments and cumulative preferred securities are two notches below the adjusted BCA; and non-cumulative preference shares are three notches below the adjusted BCA. We reverted to normal notching for all hybrid securities, including those that did not pay coupon during the two years leading to 31 January 2012 under the European Commission moratorium. Lloyds resumed coupon payment on those securities in Recent steps towards enabling the resolution of failed banks, without access to the public purse, include (1) the March 2014 publication of HM Treasury's consultation regarding the implementation of the bail-in powers introduced by the Financial Services (Banking Reform) Act 2013; (2) the July 2013 publication of HM Treasury's draft secondary legislation relating to ring-fencing and loss absorbency requirements; (3) the Financial Services Authority's publication in August 2011 of a consultation paper on Recovery and Resolution Plans, together with a discussion paper on resolution; and (4) the September 2011 proposals of the EU's Independent Commission on Banking. The aforementioned steps will be credit negative for bondholders as new structures, such as ringfencing, will be introduced to aid resolution and facilitate burden-sharing with senior bondholders in the event of bank failure. Nevertheless, the authorities do not yet have all the necessary tools to achieve the orderly resolution, particularly of the largest, most complex banks, and many of the measures under consideration (Recovery and Resolution Plans, ring-fencing) could take years to implement. Consequently, we still incorporate a very high level of support in the ratings on the largest banks, such as Lloyds. Rating Factors Lloyds Banking Group plc Rating Factors [1] A B C D E Total Score Trend Qualitative Factors (50%) C Factor: Franchise Value C Neutral Market share and sustainability x Geographical diversification x Earnings stability x Earnings Diversification [2] Factor: Risk Positioning C- Improving Corporate Governance [2] - Ownership and Organizational Complexity Key Man Risk Insider and Related-Party Risks Controls and Risk Management x - Risk Management x - Controls x Financial Reporting Transparency x - Global Comparability x - Frequency and Timeliness x - Quality of Financial Information x Credit Risk Concentration

6 - Borrower Concentration Industry Concentration Liquidity Management x Market Risk Appetite x Factor: Operating Environment B Neutral Economic Stability x Integrity and Corruption x Legal System x Financial Factors (50%) D+ Factor: Profitability E+ Improving PPI % Average RWA (Basel II) 1.36% Net Income % Average RWA (Basel II) -0.12% Factor: Liquidity C Neutral (Market Funds - Liquid Assets) % Total Assets 5.25% Liquidity Management x Factor: Capital Adequacy A Improving Tier 1 Ratio (%) (Basel II) 13.60% Tangible Common Equity % RWA (Basel II) 13.89% Factor: Efficiency D Neutral Cost / Income Ratio 78.03% Factor: Asset Quality E+ Improving Problem Loans % Gross Loans 7.40% Problem Loans % (Equity + LLR) 62.61% Lowest Combined Financial Factor Score (15%) E+ Economic Insolvency Override Neutral Aggregate BFSR Score C- Aggregate BCA Score baa1/baa2 Assigned BFSR C- Assigned BCA baa1 [1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non-public information. [2] - A blank score under Earnings Diversification or Corporate Governance indicates the risk is neutral. This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on for the most updated credit rating action information and rating history Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATION") MAY INCLUDE MOODY'S

7 CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY'S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY'S ANALYTICS, INC. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY'S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. MOODY'S CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS FOR RETAIL INVESTORS TO CONSIDER MOODY'S CREDIT RATINGS OR MOODY'S PUBLICATIONS IN MAKING ANY INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided "AS IS" without warranty of any kind. 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 or in preparing the Moody s Publications. To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY S.

8 To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER. MIS, a wholly-owned credit rating agency subsidiary of Moody s Corporation ("MCO"), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MIS have, prior to assignment of any rating, agreed to pay to MIS for appraisal and rating services rendered by it fees ranging from $1,500 to approximately $2,500,000. MCO and MIS also maintain policies and procedures to address the independence of MIS's ratings and rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold ratings from MIS and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at under the heading "Shareholder Relations Corporate Governance Director and Shareholder Affiliation Policy." For Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY'S affiliate, Moody's Investors Service Pty Limited ABN AFSL and/or Moody's Analytics Australia Pty Ltd ABN AFSL (as applicable). This document is intended to be provided only to "wholesale clients" within the meaning of section 761G of the Corporations Act By continuing to access this document from within Australia, you represent to MOODY'S that you are, or are accessing the document as a representative of, a "wholesale client" and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to "retail clients" within the meaning of section 761G of the Corporations Act MOODY'S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail clients. It would be dangerous for "retail clients" to make any investment decision based on MOODY'S credit rating. If in doubt you should contact your financial or other professional adviser.