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TEXT - S&P revises Lloyds TSB Bank PLC rating outlook
November 8, 2012 / 2:57 PM / 5 years ago

TEXT - S&P revises Lloyds TSB Bank PLC rating outlook

Overview
     -- Lloyds TSB Bank PLC (Lloyds) has recently announced a further
GBP1 billion provision in relation to payment protection insurance (PPI),
bringing the cumulative provision over the past two years to about GBP5.3
billion. 
     -- This charge, together with other exceptional items, negatively affects 
our assessment of Lloyds' capital and earnings. As a result, we are less 
likely to revise this assessment to "adequate" from "moderate" over the next 
12 months.
     -- We are therefore revising our outlook on the long-term rating on 
Lloyds to negative from stable.
     -- We are also affirming our 'A/A-1' ratings on Lloyds.

Rating Action
On Nov. 8, 2012, Standard & Poor's Ratings Services revised its outlook on 
Lloyds TSB Bank PLC (Lloyds) to negative from stable. At the same time, we 
affirmed our 'A/A-1' counterparty credit ratings on Lloyds. 

We also revised the outlook on "core" subsidiaries Bank of Scotland PLC and 
Scottish Widows PLC, and on holding company Lloyds Banking Group PLC and 
intermediate holding company HBOS PLC, to negative from stable and affirmed 
the ratings on all entities. 

Rationale
The outlook revision reflects the increasing likelihood that we will not 
revise our assessment of Lloyds' capital and earnings to "adequate" from 
"moderate" over the next 12 months. This follows Lloyds' third-quarter results 
announcement, which included an additional GBP1 billion provision in relation to
payment protection insurance (PPI), among other exceptional items. PPI 
provisions year-to-date now total about GBP2.1 billion, which has contributed to
Lloyds reporting a statutory loss before tax of GBP583 million for the first 
nine months of 2012. In our view, it appears likely that Lloyds will report a 
statutory pretax loss in 2012 and we now assume only a modest pretax profit in 
2013.

We factor an additional notch into our ratings on Lloyds, over and above its 
'bbb' stand-alone credit profile (SACP). This is in recognition of the 
significant scale of Lloyds' transition, which means that its current SACP may 
not fully reflect its true potential. This additional notch also reflects our 
view that the bank has made significant progress in repairing its balance 
sheet and our expectation that the SACP will improve by at least one notch 
over the coming 12 months. However, we now believe that there is at least a 
one-in-three chance that the latter will not occur and our negative outlook 
now reflects the risk that we may withdraw the transitory notch.

We calculate that Lloyds' risk-adjusted capital (RAC) ratio, as measured under 
Standard & Poor's RAC framework, is currently just over 6.0%, up from 5.7% at 
Dec. 31, 2011. A RAC ratio of more than 7% is one of the most important 
metrics that enables a bank to achieve an "adequate" assessment of capital and 
earnings under our criteria. For Lloyds, we project that this ratio will be in 
the 6.5%-7.0% range by end-2013, with a further improvement thereafter. 

Provisions for further material PPI charges, and other exceptional items, 
could, in our view, constrain our assessment of Lloyds' capital and earnings. 
Lloyds is not the only U.K. bank to suffer from elevated PPI charges--the 
cumulative industry provision to date exceeds GBP13 billion--but its charges are
by far the largest. In our view, this demonstrates that Lloyds' market share 
of related product sales was relatively high. Lloyds has stated that it has 
paid out GBP3.7 billion of its GBP5.3 billion provision and that a number of 
uncertainties remain as to the eventual cost. Our projected RAC range for 
Lloyds incorporates further PPI provisions, and other exceptional items, which 
we believe will encumber Lloyds' capital generation. We recognize, however, 
that the full amount of such provisions is hard to forecast. 

Lloyds reported a relatively healthy regulatory core Tier 1 ratio of 11.5% at 
Sept. 30, 2012, which is higher than several of its U.K. peers. This has 
improved from 10.8% at year-end 2011, mainly as a result of a significant 8% 
decline in regulatory risk-weighted assets year-to-date. Most notably during 
this period Lloyds has reduced its noncore assets to GBP110 billion from GBP141 
billion. By our measures, we consider that Lloyds' capitalization is not as 
strong as its regulatory ratios imply, in part reflecting our more 
conservative treatment of certain adjustments to capital, our risk-weighting 
of certain assets, and our capital treatment of its insurance business. In 
addition to the aforementioned exceptional items, our projected RAC ratio 
further reflects our view that Lloyds will continue to reduce its noncore 
assets, that pre-provision operating performance will be higher in 2013 than 
in 2012, and that the loan impairment charge will be below 100 basis points in 
2013.

Lloyds has outperformed our expectations in terms of loan impairment charges. 
In the first nine months of 2012, its reported loan impairment charge was GBP4.4
billion, compared with GBP7.4 billion in the same period in 2011. Lloyds has 
reported better performance across all of its portfolios, including its large 
U.K. retail book. We believe that an improvement in our assessment of Lloyds' 
risk position--which refines the view of a bank's actual and specific risks 
beyond the conclusions arising from the standard assumptions in the RAC 
ratio--to "adequate" from "moderate" could also drive an improvement in the 
SACP, and therefore result in the removal of the transitory notch, which we 
factor into the ratings on Lloyds. However, this remains a fairly remote 
possibility given Lloyds' weak loan-loss track record and the still weak U.K. 
economic environment. 

We base our ratings on Lloyds on the bank's "strong" business position, as 
defined by our criteria, due to its leading diversified U.K. financial 
services franchise. We view capital and earnings as "moderate", as we expect 
that the RAC ratio will remain below 7.0% over the coming 12 months. Our 
assessment of its risk position is "moderate", reflecting our view of its 
credit performance, which we consider to be worse than its peers. We view 
funding as "average" and liquidity as "adequate", due to the progress that 
Lloyds has made to bring its profile broadly in line with peers. 

The long-term counterparty credit rating includes two notches of support over 
and above the SACP, reflecting our view of Lloyds' "high" systemic importance 
in the U.K. and our assessment of the U.K. government as "supportive".

Outlook
The negative outlook reflects the increasing likelihood that we will not 
revise our assessment of Lloyds' capital and earnings to "adequate" from 
"moderate" over the next 12 months.

We could lower the ratings if we do not believe that Lloyds' RAC ratio will 
trend above and remain higher than the 7% threshold which we ascribe to an 
"adequate" capital and earnings assessment. This would most likely arise from 
further large exceptional charges in 2013 or a setback in underlying operating 
profit relative to our expectations. We would reflect this by removing the 
transitory notch that we currently include in the ratings. We see limited 
downside risk to Lloyds' 'bbb' SACP, provided that we maintain our current 
view of the U.K. banking industry, as reflected in our Banking Industry 
Country Risk Assessment (BICRA) score of '3'. 

We could revise the outlook to stable if we were to revise our assessment of 
either Lloyds' capital and earnings or risk position to "adequate" from 
"moderate" over the next 12 months, which would enable us to remove the 
transitory notch. We could revise our assessment of Lloyds' capital and 
earnings if we saw a significant increase in its underlying operating profit 
in 2013 (and a likely further increase in 2014), combined with a further 
decrease in Standard & Poor's risk-weighted assets in 2013. An improvement in 
the risk position assessment, which we consider to be less likely, could 
nevertheless occur if Lloyds materially outperformed our asset quality 
expectations.


Ratings Score Snapshot
Issuer Credit Rating         A/Negative/A-1
Bank Holding Company Rating     A-/Negative/A-2

SACP
 Anchor                    bbb+
 Business Position            Strong (+1)
 Capital and Earnings        Moderate (-1)
 Risk Position                Moderate (-1)
 Funding and Liquidity        Average and Adequate (0)

Support                    +2
 GRE Support                0
 Group Support                0
 Sovereign Support            +2

Additional Factors            +1

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