DBRS Ratings Limited (DBRS Morningstar) confirmed the Long-Term Issuer Ratings of Lloyds Banking Group plc (Lloyds or the Group) and its related entities. The Group’s Long-Term Issuer Rating was confirmed at A (high) and Lloyds Bank plc’s (the Bank) Long-Term Issuer Rating was confirmed at AA (low). Lloyds’ Long-Term Issuer Rating is positioned one notch below the Bank’s IA reflecting the structural subordination of the holding company. In addition, the Short-Term rating of the Group has been upgraded to R-1 (middle to reflect DBRS Morningstar’s approach to grant the upside mapping exception to the holding companies of banking groups. This reflects DBRS Morningstar’s view that bank holdcos typically maintain high liquidity standards, given that they are part of a of regulated entity that has demanding regulatory requirements as well as their role as liquidity provider for the broader group. The Bank’s R-1 (middle) Short-Term Issuer Rating was confirmed. The trend on all ratings remained Stable.
KEY RATING CONSIDERATIONS
The confirmation of the long-term ratings reflects the Group’s sound capacity to generate earnings, supported by its powerful retail and commercial banking franchise in the UK which is characterised by leading market shares across most retail and business segments, including a market share of 19% in retail mortgages. The higher interest rate environment has recently benefited the Group’s capacity to generate earnings. The Group’s profitability is also underpinned by strict cost discipline and risk profile characterised by generally low risk activities, with the loan book being dominated by a large domestic mortgage book. The ratings also reflect robust funding and liquidity metrics as well as Lloyds’s strong capital base, with ample buffers over regulatory requirements. DBRS Morningstar expects a deterioration in asset quality could materialise as a result of higher rates and high inflation, although non-performing loans would deteriorate from relatively low levels. In addition, in DBRS Morningstar’s view, the low unemployment rate in the UK is a mitigant.
An upgrade of the Long-Term ratings would require the Group to establish strong recurring profitability metrics over the medium term, while maintaining a resilient credit profile and robust capitalisation levels.
The Long-Term ratings would be downgraded if the Group experienced a material and sustained deterioration in profitability or significant operational and asset quality risk issues.
Franchise Combined Building Block (BB) Assessment: Strong
Lloyds Banking Group plc is one the largest UK banking groups, with total assets of GBP 878 billion at end-2022. The Group has a well-entrenched franchise in its domestic market, predominantly in retail and commercial banking, insurance and long-term investments, with strong market shares across various products, including a market share of 19% in mortgage balances, and in SME and small business lending balances, as well as a market share of 9% in home insurance, and 14% in motor finance.
Earnings Combined Building Block (BB) Assessment: Good
Lloyds has a sustained and consistent earnings generation ability supported by its market leading positions in the UK. The Group has benefited from recent interest rate rises, with the Bank of England’s key base rate at 4.5% in May 2023 compared to 0.1% at end-2021. In 2022, the Group’s net interest income (NII) increased by 18% YoY to GBP 13.2 billion. Meanwhile, other operating income (excluding the impact of operating lease depreciation) improved to GBP 5.2 billion in 2022 up from GBP 5.1 billion in 2021 thanks to higher customer activity. Lloyds compares well with its domestic and international peers in terms of cost efficiency. Operating costs increased by 6% driven by inflation and planned investments. The Group's cost-to-income ratio was 50.4% in 2022 down from 61.0% in 2021 as revenues significantly increased in 2022. Lloyds’ loan loss impairments grew to GBP 1.5 billion in 2022 compared to releases of GBP 1.2 billion in 2021 as the Group updated its asset quality models to reflect a weak economic outlook in the UK. Nonetheless, Lloyds’ credit performance remained resilient in 2022. The Group’s cost of risk was 32 bps in 2022. DBRS Morningstar notes the Group’s guidance on cost of risk for 2023 is c. 30 bps. Overall, Lloyds’s return on tangible equity was 13.5% in 2022. In Q1 2023, the Group’s performance improved further on NII growth (up 20% YoY), and contained loan loss provisions (22 bps), with Lloyds’ return on tangible equity reaching 19.1%.
Risk Combined Building Block (BB) Assessment: Good
Lloyds’ risk profile is generally conservative, with good asset quality metrics and contained deterioration to date. Nonetheless, DBRS Morningstar notes the UK economic outlook remains weak affected by high inflation, elevated interest rates, and recurrent industrial action. At end-Q1 2023, the Group's share of Stage 3 exposures (assets, which have defaulted or are otherwise considered to be credit impaired) was 2.3% unchanged since end-FY22, albeit slightly higher than prior years (end-FY21: 1.9%; end-FY20: 1.8%). However, the small increase in 2022 was largely due to CRD IV regulatory requirements which included changing the definition of default for mortgages from 180 to 90 days in the Group’s internal models. Lloyds’ risk profile is characterised by a large domestic mortgage loan book. The average LTV was 42% at end-2022, and 6% of the mortgage book had LTV above 80%. DBRS Morningstar notes nonetheless that there has been some asset quality deterioration in the interest only mortgage book in Q1 2023.
Funding and Liquidity Combined Building Block (BB) Assessment: Strong/Good
Lloyds has a robust funding profile, supported by a strong deposit franchise in the UK, reflective of Lloyds’ large and well-entrenched customer base. The Group’s net loan-to-deposit ratio was 96% at end-FY22 compared to 94% as calculated by DBRS Morningstar in previous year mainly driven by higher customer lending. The Group's liquidity is sound with a Liquidity Coverage Ratio (LCR) of 143% at end-Q1 2023, largely stable from 144% at end-2022 and above 135% at end-2021. The Group‘s Net Stable Funding Ratio was disclosed for the first time in Q1 2023, and was 129% at end-Q1 2023 vs. 130% at end-2022 based on an average of the four previous quarters. DBRS Morningstar notes 57% of total deposits are insured at end-Q1 2023. Meanwhile retail deposits represented 65% of total deposits at end-Q1 2023, of which 80% were insured. If inflation persists and rates remain high, DBRS Morningstar anticipates deposits level could reduce as spending increases.
Capitalisation Combined Building Block (BB) Assessment: Strong/Good
Despite strong internal capital generation, the Group's CET1 ratio decreased to 15.1% at end-2022 from 17.3% at end-2021, mainly due to regulatory changes which resulted in RWA inflation (risk weight floors on UK mortgages as of January 1, 2022 and the impact of finalised Basel III rules), representing a negative impact of c. 230 bps, as well as dividends and buybacks representing an impact of c. 185 bps. At end-Q1 2023, Lloyds’ CET1 ratio was 14.1%, unchanged from end-2022. The Group’s UK leverage ratio was a strong 5.6% at end-Q1 2023, stable from end-2022, and comparing well to the minimum requirement of 3.25%.
Further details on the Scorecard Indicators and Building Block Assessments can be found at https://www.dbrsmorningstar.com/research/415158
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Governance (G) Factors
DBRS Morningstar views the Business Ethics sub-factor as relevant but does not impact the ratings or trend of the Group. This is associated with the ongoing litigation issues related to customers who might have been affected by criminal activities linked to HBOS Reading but also customers claims received from the insurance business in Germany. DBRS Morningstar notes Lloyds has reported a charge of GBP 50 million in 2022 (vs GBP 790 million in 2021) in respect to this issue, increasing the cumulative charges to GBP 1,275 million. The Group has reported that the final outcome could be different once the re-review is concluded. In addition, the Group has provisioned against customer claims received from the insurance business in Germany with a total charge of GBP 709 million in 2022 and, as reported by Lloyds, DBRS Morningstar notes the outcome could be significantly different when all claims are resolved. These considerations are reflected in the Risk building block.
There were no Environmental/ Social factors that had a significant or relevant effect on the credit analysis.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (17 May 2022) https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings
All figures are in GBP unless otherwise noted.
The principal methodology is the Global Methodology for Rating Banks and Banking Organisations https://www.dbrsmorningstar.com/research/398692 (23 June 2022). In addition DBRS Morningstar uses the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings https://www.dbrsmorningstar.com/research/396929/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings in its consideration of ESG factors.
The credit rating methodologies used in the analysis of this transaction can be found at: https://www.dbrsmorningstar.com/about/methodologies
The sources of information used for this rating include Morningstar Inc. and Company Documents, Lloyds 2022 Annual Report, FY22 and Q1 2023 Investor Presentations, FY22 Results News Release, Q1 2023 Reports and Transcript, 2022 Sustainability Report and 2023 Climate Webinar. DBRS Morningstar considers the information available to it for the purposes of providing this rating to be of satisfactory quality.
With respect to FCA and ESMA regulations in the United Kingdom and European Union, respectively, this is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.
With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO
DBRS Morningstar does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.
The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. DBRS Morningstar's outlooks and ratings are under regular surveillance.
For further information on DBRS Morningstar historical default rates published by the European Securities and Markets Authority (ESMA) in a central repository, see: https://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. For further information on DBRS Morningstar historical default rates published by the Financial Conduct Authority (FCA) in a central repository, see https://data.fca.org.uk/#/ceres/craStats.
The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/415159
This rating is endorsed by DBRS Ratings GmbH for use in the European Union.
Lead Analyst: Vitaline Yeterian, Senior Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, Managing Director, Global Head of FIG
Initial Rating Date: 19 January 2009
Last Rating Date: 7 June 2022
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