Lloyds Bank's new strategy and how it beat profit forecasts

Lloyds Banking Group (LSE:LLOY) is in fine fettle but has no intentions of standing still as it has announced a new strategic update which aims to consolidate its major strengths.

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“Accelerate 2030” is broadly based on three areas of growth, namely the increasing use of intelligent AI, cross group connectivity and increasing productivity, the latter of which is expected to result in an additional £2 billion of cost savings by the end of the plan.

An early sign is that Lloyds expects some £100 million of benefits from GenAI this year alone in UK Retail before the efforts have been ratcheted up. The more measurable targets are stretching but eminently achievable given the current momentum, with the Return on Tangible Equity (ROTE) expected to exceed 18% by 2028 and then over 20% by 2030.

Alongside this, the increasing use of its digital strength, where costs have been reduced such as by the closure of branches where customer activity has changed (the bank currently has more than 22 million mobile app users) aims to reduce the cost/income ratio to below 45%, a sector-beating target.

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In the meantime, there are other pressing matters to hand. The inflationary impact of the Middle East conflict cast a shadow over the sector earlier this year, and for its part Lloyds is now booking an underlying impairment charge of £617 million, which of course anticipates potential rather than actual losses, such that releases are possible in the future should the bad debts fail to materialise. The higher figure is based on several scenarios, such as lower GDP growth in the UK, a rise in unemployment and limited gains in residential and commercial property prices. Even so, at the moment, there are few if any signs of deterioration across its lending book.

Indeed, there was positive news from a major part of the group’s more traditional lending business. Mortgages, for which Lloyds is a major player and which account for 67% of the total loan book, increased by £1.8 billion year-on-year in the first half and loans and advances overall by 2% to £491.5 billion, while deposits grew by 1% to £500.9 billion, driven largely by Commercial Banking.

Alongside the prudent provisions, higher income and lower operating costs have kept the engine running smoothly. Overall income for the half increased by 13% to £10.63 billion, while pre-tax profit spiked by 23% to £4.3 billion, where the second-quarter contribution of £2.27 billion comfortably exceeded the expected £2.1 billion. Underlying Net Interest Income (NII) grew by 9% to £7.3 billion, helped along by an improvement in the Net Interest Margin (NIM) from 3.04% to 3.19%, where volume growth and the benefit of structural hedge income were in evidence.

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What's more, the structural hedge contribution, which is designed exactly to mitigate the group’s susceptibility to changes in a falling interest rate environment, is expected to grow further and translate to more than £7 billion for the year as a whole, and over £8 billion in 2027.

The key metrics for the most part are reassuringly positive. The capital cushion, or CET1 ratio, is stable at 13.1% (and in excess of the 13% target), the cost/income ratio reduced from 55.1% to 50.4% and the ROTE spiked to 17.1% from a previous 14.1%, leading Lloyds to reiterate its full-year targets of more than £14.9 billion of underlying NII, a cost/income ratio of less than 50% and a ROTE in excess of 16%.

Meanwhile, the company's progressive dividend policy has led to a projected yield of 3.6%, while the group’s confidence was further underlined by a further £1 billion share buyback programme which adds to the £1.75 billion plan announced at the full-year results.

In addition, and coming slowly up on the rails, are those units which provide alternative sources of income such as insurance, credit cards and the UK private bank (previously called “Wealth”) and incorporating the recent acquisition of Schroders Personal Wealth (now Lloyds Wealth), where the integration is all but complete. The likely concentration of growth in these areas over the coming years will lessen the reliance on the more traditional income streams and in any event will increase the depth and breadth of revenues in due course.

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The update is strong and dependable rather than shooting out the lights and, given that Lloyds is often seen as a barometer for the UK economy, its progress has been hard-won. A neutral reaction at the open is therefore unsurprising, and may also reflect a pause for breath as investors digest the new strategic aims, following a share price which has risen by 41% over the last year, as compared to a gain of 19% for the wider FTSE100, and by 101% over the last two years.

While such strength may have lessened some of its attraction in terms of valuation, this performance continues to validate the bank’s strategy and the market consensus of the shares as a buy will no doubt hold firm.