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The Incredible Shrinking Lloyds

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LONDON -- Lloyds (LSE: LLOY.L  ) continues to demonstrate the impact of austerity. As the company shrinks its balance sheet and operations -- selling off troubled "non-core" assets and pulling out of foreign markets -- and tries to revert back to its roots as a simple U.K. retail bank, its profits are predictably shrinking as well.

No matter how you squint or how many spins management puts on the numbers -- whether they're statutory, core, management basis, or management basis core -- Lloyds is shrinking. Some of this shrinking is good -- non-core assets declined from 140.7 billion pounds at year-end to 117.5 billion pounds, and asset impairments were down 40% or 42% (depending on which numbers you look at) -- and some not so good -- the banking net interest margin (how much more in interest the bank receives that it pays out) shrunk from 2.12% last year to 1.93% this year.

While statutory losses are also shrinking, this is mainly the result of fewer "garbage loans" being written off. If we look at the core operations of the bank (on a management reporting basis, as this is likely the most flattering version of the story), we see income slipping 11% while costs only improved by 4%. Even the near-halving of the impairment charges couldn't help, as management profit slipped 5% from the first half of last year.

It isn't all doom and gloom, though. As Lloyds sheds assets (it expects to reduce non-core assets to a negligible 70 billion pounds by the end of 2014) and approaches its new-old form as a strictly retail banker, uncertainty should clear somewhat. As it stands, Lloyds and its U.K. banking brethren RBS and Barclays trade around half of their reported book values. Until investors can feel they understand what is on these banks' books and how the banking industry will look going forward, it will be hard for them to have confidence in the shares.

While the financial sector may be out of favor with investors for a while, there are others that appear much more attractive. To find out which we like, download your free Motley Fool report "Top Sectors of 2012" now.

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Nate Weisshaar does not own any of the shares mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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