Lloyds Share News (LLOY)

March 8 () - (The following statement was released by the rating agency)Fitch Ratings says that the recent results announced by the Royal Bank of Scotland Group (RBSG, 'A'/Stable/'F1'/'bbb') and Lloyds Banking Group Plc (LBG, 'A'/Stable/'F1'/'bbb') have no immediate rating implications. Fitch considers that the weak earnings reported by RBSG and LBG mask a continued improvement in core underlying profitability and balance sheet position. Both groups disclosed the progress they have made so far in reaching their stated strategy of a more balanced customer funding profile, lower reliance on short-term wholesale funds and continued reduction in non-core assets, These achievements are generally progressing faster than originally envisaged, partly because of the lack of good lending opportunities and the secondary impact on funding generated by the government's Funding for Lending Scheme.However, the agency considers that both banks' capitalisation is on the weak side despite de-risking. LBG reported a fully-loaded Basel III core Tier 1 of 8.1%, compared with a current reported core Tier 1 ratio of 12.0% and RBSG a fully-loaded Basel III ratio of 7.7%, including mitigating actions, compared with a core Tier 1 ratio of 10.3%. The main pressure on the fully loaded Basel III core Tier 1 ratio is the deduction of insurance assets for LBG, which the bank treats as a deduction against capital according to the more prudent interpretation of CRD IV. RBSG plans to raise the fully loaded Basel III Core Tier 1 ratio to 10% by end-2014 by way of continued deleveraging, further reductions in RWAs from its Markets business and the continued rundown of non-core assets. However, Fitch believes that further disposals of non-core assets will have a less meaningful effect on capital ratios due to the reduced size of these portfolios in both banks and their less liquid nature. Furthermore, we consider that capitalisation needs to be viewed in line with the continued exposure of both banks to unreserved NPLs, which accounted for about one-third of RBSG's equity and about half of LBG's. Both figures take into account the banks' continued moderate exposure to falling asset values. Both banks will need to return to profitability to ensure internal capital generation commensurate with their 'bbb' VRs, which in turn, is likely to depend to some extent on improvements in the UK operating environment. Fitch-calculated operating profit at LBG improved significantly to GBP3.7bn in 2012 (2011: loss of GBP373m). However, this figure is inflated by the realisation of one-off gains of GBP3.2bn from the sale of government securities. Legacy and one-off issues continue to have a significant impact on LBG's profitability. The statutory loss of GBP570m was affected by payment protection insurance (PPI) provisions of GBP3.6bn (including GBP1.5bn in Q412), provisions of GBP400m relating to the mis-selling of interest rate hedging products to SMEs and a GBP270m charge relating to the fair value of own debt. In aggregate, LBG has made provisions for PPI payments of GBP6.8bn, of which GBP4.3bn had been utilised at end-2012. Given the current expense rate of about GBP200m per month and LBG's expectation that this will reduce in H213, the current provision should be sufficient to meet any claims incurred during 2013. However, the full extent of future PPI costs is still uncertain and will need to be continuously monitored to ensure that provisions accommodate LBG's updated expectations. RBSG's bottom line results were weaker than 2011, again largely because of greater one-off items. However, they also benefited from stronger Markets profit, which is unlikely to be repeated given the stated plan to reduce RWAs allocated to this division and capital gains within group treasury from bond disposals of GBP0.9bn. Most business lines reported weaker operating profits in 2012 compared to 2011. One-off items at RBSG included redress costs (PPI, LIBOR and provisions against mis-selling interest rate swaps) totalling GBP2.2bn, compared to GBP0.9bn in 2011; goodwill write-down on Direct Line Group (GBP0.4bn) and group restructuring costs (GBP1.6bn). Netted off against these costs were gains on the buy-back of own debt of GBP0.5bn. A major part of the reported below-the-line costs, was the fair value loss on own debt relating mostly to improved spreads, which totalled GBP4.6bn (2011: gain of GBP1.9bn). Fitch's analysis excludes fair value adjustments on own debt, as credit analysis is based on the assumption that the nominal amount of the bank's debt will be repaid in full. Fitch considers that both banks' funding structures improved significantly during 2012, with wholesale funding continuing to reduce, and within total wholesale funding, short-term wholesale funds accounting just 30% at LBG and 28% at RBSG. Non-core asset reduction combined with deposit growth of 4% during 2012 resulted in an improvement in LBG's loan/deposit ratio to 121%, with a core loan/deposit ratio of 101% at end-2012, in line with LBG's core long-term target of 100%. RBSG reached its target 100% at end-2012.Asset quality showed differing trends between LBG and RBSG. LBG reported an improvement in its NPL ratio to 8.6% (end-2011: 10.1%), with loan loss coverage of 49.4% at end-2012 (end-2011: 49.5%). RBSG reported an NPL ratio of 9.1%, slightly worse than that reported at end-2011 (8.6%) but loan loss coverage improved to 52% (end-2011: 49%). LBG's and RBSG's impairment charges reduced significantly due to improved affordability as a result of continued low interest rates and broadly stable UK residential property prices, partly offset by subdued UK and global economic growth, high unemployment and a weak commercial real estate market.Fitch believes that both RBSG's and LBG's stated earnings objective (ROE of 12.5%-14.5% to be achieved in the medium term for LBG; return to profitability by RBSG by 2014) are ambitious in light of the significant challenges they face from the current macro-economic conditions, low interest rate environment and a greater focus on conduct risk by the UK regulators.