FINANCIAL INSTITUTIONS

ISSUER COMMENT26 February 2016

Analyst Contacts

Carlos Suarez Duarte 44-20-7772-1061VP-Senior Analystcarlos.suarezduarte@moodys.com

Maija Sankauskaite 44-20-7772-1092Associate Analystmaija.sankauskaite@moodys.com

Michael Eberhardt,CFA

44-20-7772-8611

VP-Sr Credit Officermichael.eberhardt@moodys.com

Laurie Mayers 44-20-7772-5582Associate ManagingDirectorlaurie.mayers@moodys.com

Nick Hill 33-1-5330-1029Managing Director -Bankingnick.hill@moodys.com

Lloyds Banking Group plc2015 Results Commentary

Lloyds Banking Group plc’s (LBG, Baa1 positive) full-year 2015 results show strong profitgeneration being offset by large conduct remediation costs. Despite the sizable conduct cost,the group reported strong capital metrics, even after incorporating the ordinary and specialdividend payments. Cost of risk remains low while funding and liquidity remain solid.

LBG reported statutory profit before tax of £1.6 billion, a 7% decline compared to 2014. Thedecline was mainly driven by an additional £4 billion in provisions in 2015 for the mis-soldpayment protection insurance (PPI) products, up from £2.2 billion in 2014. The group decidedto take an additional £2.1 billion of PPI provisions during the fourth quarter following theproposal by the Financial Conduct Authority (FCA) to introduce a deadline for customersto claim compensation1 and the additional guidance on how to handle PPI complaints inwhich an unfair relationship might have arisen if the lender failed to disclose to the customera commission of 50% or more of the premium amount. The total PPI provision now standsat £16 billion, of which £3.5 billion remains unutilised, and LBG calculated it should coverall future claims and related administration costs until mid-2018, assuming current FCAproposals are implemented and that customer complaints do not exceed an average of10,000 per week. While the group reports the average volume of reactive PPI complaintsreduced by 8% to 8,000 per week in 2015, we note the introduction of a deadline on claimsmight accelerate the complaints volume beyond the assumed levels and require additionalprovisions to be taken in the future. In addition to the PPI charges LBG made a £837 millionprovision for other conduct remediation liabilities in 2015, of which £302 million was setaside in the fourth quarter.

Exhibit 1

LBG’s incurred record high conduct related costs in 2015

Source: LBG financial statements

More positively, underlying profit generation remained strong. Pre-tax income, adjustedfor conduct provisions, asset sales, contribution of deconsolidated TSB Banking Group plc

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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 onwww.moodys.com for the most updated credit rating action information and rating history.

2 26 February 2016 Lloyds Banking Group plc: 2015 Results Commentary

(TSB, rated Baa3 stable) and business simplification costs, increased by 10% to £8 billion in 2015. Net interest income for the periodamounted to £11.5 billion, 5% higher year-on-year as a result of stronger net interest margin (2.63% compared to 2.40% in 2014).The redemption of LBG’s Enhanced Capital Notes (ECN)2, will contribute positively to the group’s net interest margin, althoughthese savings could be reversed in the form of additional costs, if the UK Supreme Court decides that a disqualification event hasnot occurred and orders the group to compensate ECN holders. We expect LBG to face some negative pressures on its net interestmargin driven by increased competition in UK retail and commercial banking. Due to the negative impact of run-off asset disposalsunderlying other income went down by 5% in 2015. Fees and commissions income fell by 6%, partly offset by strong Insurance divisionperformance (6% increase in contribution to the group’s other income). Excluding conduct remediation costs, LBG continues tomaintain good efficiency levels and reported flat operating costs and cost-to-income ratio of 49.3% in 2015. In addition, the groupbenefitted from a 48% drop in impairment charges.

LBG’s asset risk continues to decline on the back of the favourable operating environment in the UK and asset disposals. The reportedimpaired loan ratio decreased to 2.1% as of December 2015 from 2.9% as of December 2014. During the year the group sold £2.6billion of Irish commercial loans, thus almost fully eliminating its exposure to commercial lending in Ireland (£37 million gross lendingremains). Cost of risk reported in the period was 14 basis points, 9 basis points lower than in 2014. Lower loan impairments, however,resulted in a 10 percentage points decrease in impaired loan provision coverage to 46.1% from 56.4%. Given the continuous de-riskingwe view this level of provisioning as appropriate.

Exhibit 2

Asset risk continues to decline

Source: LBG results presentations

The group reported a fully loaded common equity tier 1 (CET1) ratio of 13% at December 2015 on a pro-forma basis, down from 13.7%as of September 2015 driven by the losses posted during the last quarter of 2015 and the dividend payments. Excluding dividendpayments, CET1 would have increased to 13.9% on a pro-forma basis as of December 2015 from 12.8% as of December 2014. Wepositively note that the group was able to maintain its target CET1 ratio and pay dividends after facing sizable conduct costs. However,we remain concerned about the potential effect on LBG’s CET1 of the introduction of changes in regulatory measures such as theimposition of risk weighted asset (RWA) floors. The group will publish its 2015 pillar 3 disclosures in the coming weeks, but as of year-end 2014 the average RWA floor of its residential mortgage portfolio was 11%. In addition, The Group’s ICG has increased, such that at31 December 2015 the top up to Pillar 1 (or Pillar 2A) represented 4.6 per cent of risk-weighted assets of which 2.6 per cent had to becovered by CET1 capital. The Group believes that the increase in Pillar 2A reflects the impact of market and economic factors and thereduction in risk-weighted assets rather than any fundamental changes to the nature of the underlying risks. However the Group is notpermitted by the PRA to give any further details of the quantum of the individual components.

LBG’s leverage ratio declined to 4.8% as of December 2015 from 4.9% as of December 2014.

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3 26 February 2016 Lloyds Banking Group plc: 2015 Results Commentary

Exhibit 3

LBG’s fully-loaded CRDIV CET1 and leverage ratios

Source: LBG results presentations

LBG’s loan-to-deposit ratio increased to 109% as of December 2015 from 108% as of December 2014, mainly driven by the disposalof TSB. The group increased its wholesale funding by 3% between December 2014 and December 2015 to £120 billion, despite themuted growth of its loan portfolio. However, the amount of wholesale funding with a maturity of less than 1 year declined by 8% to£38 billion. Although LBG did not provide any information regarding the level of its net stable funding ratio (NSFR), it said that itsliquidity coverage ratio (LCR) is above 100%. We believe that the increase in the group’s LCR eligible liquid assets to £123 billion as ofDecember 2015 from £109 billion as of December 2014 is credit positive.

LBG also provided further clarifications on its proposed legal structure to comply with the ring-fencing framework. The group expectsto allocate about 97% of its lending within the ring-fenced bank (RFB), leaving the remaining assets, including insurance businesses,out. Given the simple structure and the proportion of assets to stay within the RFB, we believe the transfer process will be lesschallenging and likely less costly for the group than for its larger peers.

LBG’s primary operating bank subsidiary, Lloyds Bank plc, has a standalone baseline credit assessment of baa1. Its bank deposits andsenior debt are rated A1. The holding company’s senior debt is rated Baa1. The outlook on the ratings is positive. Results for 2015are supportive of the current ratings, which incorporate improving trends in asset quality and capitalisation and our expectation ofeventual stabilisation of profitability as legacy conduct issues resolve.

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4 26 February 2016 Lloyds Banking Group plc: 2015 Results Commentary

Endnotes1 See ''UK's Proposed Deadline for Sales Complaints Is Credit Positive for Large Lenders'', 8 October 2015

2 See ''UK Court Decision Is Credit Positive for Lloyds Banking Group'', 17 December 2015

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5 26 February 2016 Lloyds Banking Group plc: 2015 Results Commentary

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