Lloyds: Mind the GAPS
Lloyds has put out a statement today that it is still exploring alternatives to making any use at all of the "Government Asset Protection Scheme" (which apparently is now known as "GAPS" - presumably because it is supposed to fill the "gaps" or gaping holes in its balance sheet).
If you read my note of last week, in which I said that Lloyds was trying to pull out of GAPS or scale down its involvement in the scheme, you will think this isn't news.
But actually quite a big thing has happened since. Which is that Lloyds has been told by the Financial Services Authority how much capital it would need to raise were it to abandon entry into GAPS.
And the City watchdog has told Lloyds it would need to raise more than £5bn in excess of what Lloyds thought it would have to raise - which, in order to confuse you, I will call the GAPS gap.
Which means that were it to remain outside of GAPS, Lloyds would have to raise well over £20bn of new capital, though not quite £30bn.
This is a big chunk of change. And when Lloyds' directors heard the news, they were bitterly disappointed, because they are desperate to minimise the succour they receive from government, from taxpayers.
However, raising more than £20bn is a tall order for a bank whose total market value is only £30bn.
Which is why yesterday and overnight there was a flurry of reports that Lloyds would inevitably remain in GAPS.
Now, that may turn out to the case. That said, Lloyds is shouting loudly that it will make a last-ditch attempt to raise the capital needed to steer clear of GAPS.
Why Lloyds' visceral horror of becoming more dependent on the state?
Well, the explanation is largely commercial.
Before elucidating, it probably makes sense to remind those of you who aren't bonkers for banks why Lloyds and its ilk need capital and how GAPS serves as an alternative to capital.
All banks require capital as a buffer to absorb losses on loans and investments that go bad. Without capital, those losses would fall on depositors (a big hello to you and me). And so depositors would never keep their money in a bank that had inadequate capital.
In other words, banks with too little capital are either bust or a long way down the road to the arid land of bankruptcy.
Earlier this year, a couple of our biggest banks - Lloyds and Royal Bank of Scotland - were both judged by the Financial Services Authority to require a truckload of additional capital, because they faced colossal future losses on their reckless lending and investing.
And, by the way, it's part of the FSA's mandate to adjudicate on the capital needs of banks, which is a task it performed inadequately for many years (though is probably doing a bit better now).
At the time, in the bleak mid-winter, the mood in the markets was of panic and despair. Lloyds and Royal Bank were unable to raise the necessary capital from commercial sources: there was little appetite to invest in them.
The necessary capital could have come from the state, from taxpayers. But this would have meant almost complete nationalisation of Lloyds and Royal Bank, which were (and are) already owned to the tune of 43% and 70% respectively by taxpayers.
For whatever reason, the government decided it did not want even more control over these two banks. So it designed an alternative way of strengthening them, of protecting the banks and their depositors from the losses that would be incurred on their loans and investments.
This was GAPS, which is - broadly - an insurance scheme.
The two banks were to put £585bn of loans and investments (or assets) into GAPS.
Lloyds and Royal Bank would incur the first 10% of losses on these losses. But taxpayers would suffer 90% of any losses after that first 10%.
So taxpayers - all of us - were in effect becoming human capital, living-and-breathing loss absorbers for banks.
Which may not appeal to you. But fear not. The Treasury did not volunteer our services for nothing. It insisted that the banks pay a fee for GAPS.
And one of the things that Lloyds doesn't like about GAPS is that it thinks the fee is too steep. Some of Lloyds shareholders agree - which is why, now that markets and the economy have recovered a bit - they are prepared to provide capital to Lloyds, to invest more in the bank, in a way that they weren't prepared to do seven months ago.
There is another reason why Lloyds doesn't like GAPS: it is state aid; and as state aid, it gives considerable sway to Neeilie Kroes, the European Competition Commissioner, to interfere in its affairs.
The point is that she has a mandate to dismantle any giant bank that's in receipt of taxpayer support. And Lloyds, having bought HBOS, is a prime candidate - or so she thinks - for break up.
Here's the formula that Lloyds hates: the more state aid it receives, the greater the disposals which she can force on it (or so the bank thinks).
Which is why Lloyds wants to minimise its use of GAPS, so as to give Neelie Kroes less power to hive parts of it off (that said, bankers close to Lloyds tell me that the widely circulated notion that it might be forced to sell off all of Halifax's branches - which it acquired with HBOS - is incorrect).
So what is Lloyds going to do now?
Well it will move heaven and earth over the next fortnight to try to raise the £20bn plus.
If it succeeds, this would involve a rights issue of new shares of up to £10bn, the conversion of well over £10bn of lower quality capital into better quality pure equity, and a major disposal.
Will Lloyds pull this off in the time available? Odds must be slightly against.
So, as I said last week (which may make you wonder why you've bothered to read this far - if indeed you have), the chances are that Lloyds will go for a hybrid, a mixture of a scaled-down commitment to GAPS and a smaller fund raising.
There is, however, one more point to make.
The Bank of England has this morning published figures which showed yet another decline in the flow of new lending to households and businesses. Much of this is due to a collapse in demand for credit, as borrowers - wholly rationally - decide to reduce their indebtedness.
But some of the shrinkage in the stock of lending is due to banks' increased reluctance to lend. Which, in the long run, is a good thing - although any acceleration in the contraction of lending would be very damaging right now, when the economy is wavering between recovery and relapse.
So some may think that Lloyds should be obsessing less about how it raises capital - so long as it raises enough - and rather more about how it can make a bigger contribution to pulling the UK out of the economic quagmire which it (its HBOS bit in particular) and its competitors helped to create.