Lloyds Banking Group has angered its bondholders with a plan to redeem at par £700m of so-called enhanced capital notes it issued as part of its 2009 recapitalisation following its disastrous acquisition of HBOS.
Lloyds issued £8.3bn of the notes that turn into equity if its core tier one capital ratio falls below 5 per cent. The Financial Services Authority, the regulator of the day, treated the notes as capital in its stress tests. Lloyds called £5bn of them last year. It no longer needs them and they are costly.
Bondholders are angry because the notes, with coupons of between 6.4 and 16.1 per cent, have been a boon while rates are low. They are also upset by Lloyds’ reading of the terms. The bank says it can call the notes at par if there is a “capital disqualification event” — for example if they “cease to be taken into account” in its core tier one ratio.
Roll forward to last year’s tests by the Prudential Regulation Authority, the FSA’s successor, and capital metrics and definitions have changed. Its stress hurdle rate was a common equity tier one (not the same as core tier one) capital ratio of 4.5 per cent. Lloyds passed, with a ratio of 5 per cent — without the ECNs. They were not disqualified, just not needed. Because of today’s changed capital definitions, the original 5 per cent core tier one conversion trigger is probably closer to a 1 per cent common equity tier one ratio now. After the stress test results, Lloyds (not the PRA) decided a capital disqualification event had occurred.
Yet it is hard to avoid the impression that the bank is using the tests (and the PRA’s blessing to call the notes) to justify redeeming costly debt. BNY Mellon, trustee for the notes, wisely wants a declaratory judgment on the ECN terms from the court.
It should not have come to this. Lloyds, with £12bn already set aside for payment protection insurance claims, can ill-afford reputational self-harm. That it is braving the court smacks of a bank whose returning capital strength is now matched by a worrying swagger.
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