A key part of the banks plan to strengthen its balance sheet has been to sell off mortgage assets. In particular, the banks loss-makingIrish operation, which had 19.7bn of net exposure at its peak in 2010. Now, after years of unwinding, the mortgage book has fallen to around 6bn.
Of this 6bn, theres only 1bn ofnet exposure to Irish non-performing loans. The rest of the book is still performing but forms part of the banks non-core Irish division, which is being steadily wound down.
Winding down its mortgage portfolio should help strengthen Lloyds balance sheet. Further, as the bank cuts costs over the next few years profitability and cash generation should increase.
Lloyds three-year plan will involve9,000 job losses and 200 branch closures. 50 new branches will be opened in under-represented areas.
Additionally, 1bn will be invested to boost the banks online offering, it plans to develop new technology that will mean mortgages being approved in seven days, rather than 25, and business clients being signed up within a week instead of six. According to CEO,Antonio Horta-Osorio, Lloyds wants to beas lean and as mean as possible.
These changes should save the bank 1bn per annum. Services previously offered by these branches will be available online at a fraction of the cost to the bank.Moreover, its estimated that as a result of cost cutting, Lloyds return on equity a key measure of profitability will jump to 13.5% to 15% by the end of 2017. A high return on equity not seen since before the financial crisis, although this time the bank is taking less risk to achieve the return.
Unfortunately, while Lloyds itself makes changes to boost profitability,the recent changes to UK bank taxation rules will impact profits over the next few years. The new rules, introduced by the Chancellor in the autumn statement, cap the amount ofprofit in established banks that can be offset by losses carried forward.
At present, banks are allowed to carry forward losses racked up during the financial crisis to offset profit and eliminate their corporate tax bill. The profit cap will be set at 50%.
This cap is expected to raise 3.5bn for the exchequer over the next three years, a good chunk of which will comes from Lloyds, although other banks such asRBSandBank of Americawill be hit as well.
Still, as the cap is only designed to eliminate losses incurred during the financial crisis, it should not have much effect to forecasts over the long-term.
The bottom line
Lloyds has spent the last few years recovering from the financial crisis but the bank is now in better shape than ever before. Cash generation is increasing and managementhas outlined plans for growth.
However, the real test will come when the Bank of England releases the results from its recent stress test. Lloyds only just passed the European Central Banks stress test, conducted earlier this year but the bank has been working to strengthen its capital position ever since. The BOEs test should reveal a marked improvement in the banks financial stability.
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