Five U.K. Banks Receive Morningstar Credit Ratings

In our Stress Test analysis, we assigned an above average underwriting rating for Barclays' loans and securities. Barclays received a score of very good in the Stress Test, as it was able to add capital to its already strong starting capital position under our stress-case assumptions. Barclays achieved a poor Solvency Score, as its sound capital position was hampered by recent poor earnings, a higher balance of nonperforming loans, and lower reserves. We awarded Barclays a fair Business Risk score, as its size and business line diversification was hindered by the absence of an economic moat. These factors led to a rating of A-.

HSBC
Morningstar is initiating credit coverage of HSBC Holdings (HSBA) with an issuer rating of A+. London-based HSBC has around 8,000 offices in nearly 90 countries and is among the largest banks in the world. It operates in Europe (50% of assets), Hong Kong (15%), other Asia Pacific (10%), Middle East (2%), North America (20%), and Latin America (5%). HSBC's personal financial services accounted for just more than 30% of operating income before loan-loss provisions in 2010. Global banking and markets and commercial banking accounted for 30% and 40%, respectively. HSBC is among the best-capitalised global banks, especially considering its lower-risk business model. We're especially fond of its strong deposit funding base, which is much more stable than the wholesale funding used extensively by most of its peers. HSBC’s exposure to the sovereign debt of troubled European governments like Portugal, Italy, Ireland, Greece, and Spain (PIIGS) is minimal and represents only about 7% of core Tier 1 capital. HSBC, however, is exposed to nearly every economy in the world, and the global slowdown has negatively affected its results. We are concerned with possibility of a bubble forming in Asia where HSBC has significant exposure.

In our Stress Test analysis, we assigned an above average underwriting rating for all of HSBC’s loans and securities. HSBC received a score of very good in the Stress Test as it was able to build capital under our stress-case assumptions. HSBC achieved a good Solvency Score as its sound capital position and excellent deposit to loan ratio were only slightly hampered by marginal reserves. We awarded HSBC a very good Business Risk score due to its size, business-line diversification and wide economic moat. These factors led to a rating of A+.

Lloyds Banking Group
Morningstar is initiating credit coverage of Lloyds Banking Group (LLOY) with an issuer rating of BBB. London-based Lloyds is a financial services firm that operates primarily in the U.K. through its retail bank, insurance group, and wholesale and international banking units. Lloyds more than doubled in size when it acquired rival HBOS, and now controls 30% of the U.K. mortgage market and 50% of its savings market. Lloyds' current capital structure is much more stable than it was during its precrisis condition. Tier 1 capital has increased from approximately 6% to over 11%, and its dependence on wholesale funding, especially short-term wholesale funding, has declined materially. The combined Lloyds-HBOS has substantial exposure to the U.K. property market, where sharp declines in property prices will mean elevated loan losses for some time. Lloyds holds over £25 billion of Irish loans, more than half of which are impaired, and losses associated with these loans continue to significantly impact Lloyds' profitability. Lloyds' exposure to the sovereign debt of troubled European governments like Portugal, Italy, Ireland, Greece, and Spain (PIIGS) is immaterial.

In our Stress Test analysis, we assigned an average underwriting rating for Lloyds' commercial real estate and consumer loans, and an above average underwriting rating for the remaining loans and securities. Lloyds received a score of very good in the Stress Test, as it only lost a minimal amount of capital under our stress-case assumptions. Lloyds achieved a very poor Solvency Score due to its mediocre capital levels, lower reserves, recent poor earnings, and a higher balance of nonperforming loans. We awarded Lloyds a fair Business Risk score as its size and business line diversification were hindered by the absence of an economic moat. These factors led to a rating of BBB.

Royal Bank of Scotland
Morningstar is initiating credit coverage of Royal Bank of Scotland (RBS) with an issuer rating of BBB+. Through acquisitions, Royal Bank of Scotland has become a global bank with operations in 50 countries. RBS is primarily a business bank, and is dominated by its global banking and markets division, which has historically generated about 40% of profits. In 2009, RBS formed a noncore division, holding about 10% of assets, which largely will be run off by 2013. The firm generates more than 65% of its profits in the U.K., and owns Ulster Bank in Ireland and Citizens Bank in the United States. Post the 2008 bailout, RBS is essentially a government-run bank with the U.K. government holding a majority of its shares. RBS’s elevated level of nonperforming loans is mostly due to its Irish loan book, where the company has taken heavy property losses. RBS’s exposure to the sovereign debt of troubled European governments like Portugal, Italy, Ireland, Greece, and Spain (PIIGS) is manageable at about 23% of core Tier 1 capital.

In our Stress Test analysis, we assigned an above average underwriting rating for RBS’s loans and securities. RBS received a score of very good in the Stress Test as it only lost a minimal amount of capital under our stress-case assumptions. RBS achieved a poor Solvency Score due to its mediocre capital levels, lower reserves, recent poor earnings, and a higher balance of nonperforming loans. We awarded RBS a fair Business Risk score as its size and business-line diversification was hindered by the lack of an economic moat. These factors led to a rating of BBB+.

Standard Chartered
Morningstar is initiating credit coverage of Standard Chartered (STAN) with an issuer rating of A+. Standard Chartered has its headquarters in the U.K. but has operations almost exclusively in Asia, Africa, and the Middle East. Its biggest markets are India and Hong Kong, combining to produce about 38% of the group's profits, with other Asia Pacific (18%), the Middle East (14%), Singapore (12%), Africa (9%), and the rest of the world (9%) rounding out its portfolio. Its wholesale banking operations dominate, commanding about 75% of risk-weighted assets. Standard Chartered's strategy is to continue to build out its network in Asia, Africa, and the Middle East, so its fortunes are closely tied to the economic health of these occasionally unstable regions. After its surprise late 2010 capital raise, Standard Chartered's core Tier 1 ratio is about 12%, making the bank very well capitalised. Standard Chartered’s exposure to the sovereign debt of troubled European governments like Portugal, Italy, Ireland, Greece, and Spain (PIIGS) is immaterial.

In our Stress Test analysis, we assigned an average underwriting rating for most of Standard Chartered’s loans and an above average rating for most of its securities. Standard Chartered received a score of very good in the Stress Test as its strong initial capital levels experienced only a slight loss of capital under our stress-case assumptions. Standard Chartered achieved a good Solvency Score as its sound capital position and excellent deposit to loan ratio were only slightly hampered by marginal reserves. We awarded Standard Chartered a good Business Risk score due to its size, geographic diversification and narrow economic moat. These factors led to a rating of A+.