Lloyds desperate to pull out of toxic-asset insurance plan

Bank in talks with Treasury over possible alternatives to state-backed protection

Lloyds Banking Group is in talks with the Treasury about whether it can withdraw from the Government's toxic-asset insurance scheme because it believes the economic situation has improved.

The news emerged a day after watchdogs at the Financial Services Authority told Lloyds it had no choice but to participate in the programme after failing the FSA's stress tests.

The beleaguered bank, which is 43.4 per cent owned by the taxpayer, confirmed it was "considering possible alternatives" to entering into the Government Asset Protection Scheme (Gaps), an insurance plan for securities that have become untradeable since the financial crisis.

One analyst said: "No one is surprised that Lloyds has gone down this route of trying to put fewer assets in the scheme or getting out of it altogether, but it will be a balancing act for them. It heavily depends on what the regulators, the bondholders and the credit rating agencies want."

Lloyds is in talks with the Treasury, the FSA and UK Financial Investments, the body that manages the Government's banking stakes. "All possibilities remain open and, as part of this process, Lloyds is focused on ensuring that any potential alternatives to Gaps would be in the interests of shareholders and other stakeholders," a spokesman for the bank said, adding that an option was to reduce the amount of Lloyds assets covered by Gaps.

Lloyds said it had taken the step "in light of improving economic conditions and the results of Lloyds's detailed review of its loan portfolios and their expected performance". The bank's shares were among the most heavily traded yesterday, but its price fell by 1.5 per cent to 108p.

The FSA is understood to have blocked Lloyds's withdrawal from the scheme in favour of a rights issue, a move that institutional investors would probably be willing to back.

There has also been talk this week that the bank is looking to sell assets to raise funds. The FSA ran a series of stress tests on Lloyds and concluded that it need to raise more than the proposed £15bn to cover its bad debts.

"The group would clearly like to lighten its participation in Gaps or leave it, but other stakeholders may have a different view. It would have to be pretty sure it can prosper if it withdraws, and it certainly would be a big message to the market," added the analyst.

Lloyds announced in March that it intended to hand over £15.6bn in B shares to the Treasury in return for placing £260bn of risky, toxic loans into the Gaps programme. The move was expected to raise the taxpayer's stake in the bank to 65 per cent if the holding was converted into ordinary shares.

However, Lloyds is keen to avoid the scheme because it views it as expensive. It needs to burn through £25bn of losses on its assets before Gaps comes into force. Although the bank has lost £10bn on these assets already, it feels the decline is slowing. Much of the debt stems from Lloyds's disastrous takeover of Halifax Bank of Scotland. It revealed in July that it had made a pre-tax loss of £4bn and had written off £13bn in bad loans – 80 per cent of which had come from HBoS. At the time the chief executive Eric Daniels, who said the Gaps scheme was "like a householder's fire insurance" that Lloyds might not actually need, said its bad debts "had probably peaked".

Entrance to the Gaps programme could also incur the wrath of European legislators, according to some analysts.

Lloyds is afraid that the EU, which opposes state-backed monopolies, could force it to sell core assets and reduce its market share. One expert said yesterday: "It would be crazy to unpick [Lloyds]. We need strong banks."