At first glance it seems as if Lloyds (LSE: LLOY) (NYSE: LYG.US) has recovered from the financial crisis and the bank’s ill-fated acquisition of failing peer, HBOS. However, dig a bit deeper and it becomes clear that the bank’s recovery is still far from complete.
Skeletons in the closet
The scale of Lloyds’ lack of progress was brought to light at the end of last month, when the ECB revealed the results of its asset quality review and stress tests.Â
Indeed, the tests revealed that after a simulated three-year period of stress, Lloyds’ common equity Tier 1 capital ratio fell to 6.2%, only 0.7% above the required minimum of 5.5%. This terrible performance surprised many analysts and the bank tactually performed worse than struggling peer RBS.
That being said, Lloyds’ management was quick to point out these results were put together with last year’s numbers. The Bank of England’s own stress tests, which are set to take place over the next few months, should give a more up-to-date picture of Lloyds’ finances.
Still, it’s unclear how the bank will progress going forwards. It’s obvious that Lloyds needs to build up a larger capital cushion but management is targeting an additional £30bn of loans to customers as part of its new three-year strategy, with the aim of increasing its stock of mortgage lending by £20bn. This aggressive balance sheet expansion will only increase the need for additional capital.
Further, mounting provisions for payment protection insurance continue to haunt the bank. Lloyds was forced to set aside a higher than expected amount of £900m in the third quarter to meet PPI claims — this is excluding fines levied on the bank for other ‘serious failings’.
Then of course there’s Lloyds’ dividend, which the bank has been promising to reinstate for some time now. If the balance sheet is not up to scratch then regulators are unlikely to let the bank return cash to investors. Â
Cutting costs
In an attempt to cut costs and boost cash generation, Lloyds is planning to cut more than 9,000 jobs and close around 200 branches — these moves will reduce the bank’s headcount by around 10%. The cost of the restructuring will be around £1.6bn over three years. Along with layoffs Lloyds is planning to automate basic banking services and modernise its branch network.Â
These cuts are expected to help Lloyds generate £1bn a year in cost savings by 2017. Management also believes that a lower cost base will help the group drive up its return on equity — a key measure of profitability — to around 15% by 2017. However, many City analysts are sceptical of this lofty target as Lloyds is only slated to report a return on equity of 5.5% for this year.Â
The bottom line
So overall, Lloyds has made some progress since the financial crisis but there is still plenty of work to be done. The bank’s balance sheet still needs work and return on equity remains depressed. Only time will tell if Lloyds’ restructuring plan can return the bank to growth.Â