Escaping the state should cost Lloyds

October 14, 2009

Lloyds Banking Group may yet succeed in getting out of jail. But breaking free from the British government’s insurance scheme for toxic assets should not be cheap. True, details of the scheme were never finalised. But Lloyds — and its shareholders — have benefited from the promise of state support. Ministers are right to insist that it pays up.

When Lloyds signed up to the government’s asset protection scheme (GAPS) back in March, investors had lost confidence in the bank. The scheme allowed Lloyds to cap losses on assets worth 260 billion pounds while removing the threat of nationalisation. Its shares have since trebled in value.

Now that confidence has returned, Lloyds wants to escape the GAPS. This will not be easy: the bank will have to raise about 25 billion pounds in fresh capital — equivalent to its current market value — to support the loans that will no longer be insured. This may require the government, which owns 43.5 percent of Lloyds, to support a rights issue.┬áIf the authorities approve Lloyds’ escape, it seems right that the bank should pay for the support it has enjoyed so far. The question is how much.

There are two ways of looking at this. The first is based on the example of Bank of America, which agreed to insure assets worth $118 billion with the U.S. government in January this year before backing out four months later. After some wrangling, BofA last month paid $425 million for the support it had received. This is equivalent to 0.1 percent of the insured assets for each month the support was in place. On this basis Lloyds, which insured a larger pool of assets for a longer period of time, would have to pay about 1.8 billion pounds.

An alternative is to look at the 15.6 billion pound premium that Lloyds agreed to pay for the insurance over a seven-year period — equivalent to 186 million pounds a month. So the bill for seven months of support would be 1.3 billion pounds.

Lloyds executives will no doubt argue that this is not necessary. After all, the government has benefited from the share price rally through its large shareholding in the bank. Charging a hefty fee would look a bit like transferring cash from one pocket to another — especially if the government then recycled some of the cash through a rights issue.

But there are bigger principles at stake. When taxpayers offer explicit support to banks, they should be compensated for the risks they assume — even if these prove to be less bad than feared. After all, had the government not intervened in March, Lloyds would probably be bust and its shares worth nothing.

Besides, demanding a fee is politically smart. Allowing Lloyds to wriggle free from state support is bound to be controversial. The government stands a better chance of winning support for the decision if it can show taxpayers a cheque. It should settle for nothing less than 1 billion pounds.

Previous Reuters columns on Lloyds and the GAPS:

Oct 8th – Lloyds’ great escape still a stretch

Sep 4th – Lloyds must pay to escape state support

Aug 10th – The rights escape for Lloyds

August 4th – Time for Britain to close the GAPS

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