Lloyds’ strategies for creating shareholder value - Strategic Management

Lloyds implements three basic strategies to achieve the goals stated above. Reallocation of assets This strategy for creating shareholder value has transformed Lloyds from a diversified international bank into a focused domestic bank. Lloyds’ policy is to focus on the strengths of the market, not necessarily domestic investment versus international activities. Although it has recently disposed of some UK assets (selling its stake in Yorkshire Bank and closing its gilts and eurobond operations) and acquired others abroad (Abbey Life in Ireland and Germany), the larger proportion of its business is in the UK.

Its 62 per cent international assets in 1981 had been reduced to 28 per cent by the end of 1990. The significantly wider domestic net interest margins reflect a large component of consumer and small business lending funded from a base of cheap retail deposits. The international segment was wholesale in orientation, geared to low margin, euro-currency and large corporate lending. Now this is focused on international private banking in those countries where Lloyds is not a major player in the retail market.

Lloyds has moved away from low margin euro-currency lending and sold international offices in the USA, Canada and Portugal. It has also enhanced value to shareholders by recognising that growth, to compensate for declining (at the time) corporate loan margins, must come from other areas, such as increasing arrangement and lending fees, and enhancement of the personal customer base (thus Lloyds’ acquisition of Abbey Life). Lloyds estimates that its interest margin is almost 25 per cent higher than the peer group average because of its low percentage of international assets. Seeking selective market leadership Lloyds’ second strategic principle concerns competitive advantage. Its stated policy, which underlies its switch from international to domestic assets, is to seek selective market leadership and to avoid those markets and products where it cannot obtain a strong position. It pulled out of gilts and eurobond operations in 1987, for example, because ‘markets were overcrowded and we were marginal players’.

High margin/low capital intensive businesses In keeping with its policy of producing high affordable dividends (distributable returns) Lloyds has sought balance sheet growth by moving away from low margin commodity lending into risk management and fee-based services. Development of its life assurance subsidiary, Black Horse Life, began with the acquisition of a 57 per cent stake in Abbey Life, projected to generate significant cash flow from its existing client base. This is expected to prove extremely effective in terms of capital cost regulatory requirement (cash holdback) as requirements are minimal in relation to the costs of lending under the BIS rules. Although embedded value life profits are not technically distributable, they can be included within the group’s capital and so effectively free up banking-derived earnings for distribution. Lloyds’ focus on high margin areas like personal and small business lending has resulted in a higher yield on its domestic assets and stronger net interestmargin than its peers.

The results of Lloyds’ adherence to its strategic principles has produced amazing results since 1986 (see Figure): its pre-tax return on assets was 185 per cent better than peers in 1990 against 33 per cent in 1986.


Difficulties in implementing a value approach
The problems experienced by Lloyds in implementing VSM were primarily technical and involved retraining its own financial experts and those within the investing community to think of cash flow in terms of ‘free cash’ or ‘affordable dividends’ to shareholders rather than cash flow in the traditional sense. Lloyds’ experience with the investing community was that, with a few notable exceptions, there was little awareness of, but a lot of interest in, the value techniques. Its regular meetings with analysts and fund managers has succeeded ‘only up to a point’ in educating and convincing the investing community of the benefits of managing for value. ‘They [the investors] are convinced by the results, but not by the theory.’ Lloyds feels its value strategy can be summarised as:

  1. Ensuring profitability of ongoing businesses without going to its shareholders for more capital.
  2. Reducing investment in those parts of the business which cannot realistically expect long-term returns which exceed the cost of equity.
  3. Increasing investment in high return businesses.

Overall, Lloyds’ objective is to maximise shareholder value, which means ‘maximising the present value of (estimated) future affordable dividends’. It does not attempt to maximise ROE but instead to take on all business which at the margin will generate 18 per cent ROE. Lloyds believes that maximising ROE does not maximise shareholder value. Rather, it feels that success is better measured by the actual change in shareholder value over time.

When asked if it felt it would be a takeover target in the future, Lloyds’ opinion was that it would not: ‘Management is already maximising returns forshareholders.’ Indeed, if the sentiments of many of the analysts surveyed are to be believed, it is a share to buy. To quote one: ‘Lloyds Bank represents the best combination of dividend productivity and cheapness and should be the core long-term holding in portfolios’ (UBS Phillips and Drew).

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