Lloyds ECNs tumble as investors prepare for the worst

Fri Feb 14, 2014 11:50am EST

LONDON, Feb 14 (IFR) - Lloyds fired a warning shot about the regulatory value of its ECNs on Thursday, sending the instruments tumbling in a move reminiscent of Credit Suisse the previous week and fuelling fears that banks are hardening their stance on now useless capital instruments.

On an investor call held following the release of its fourth quarter earnings, Lloyds faced an anxious pack of investors desperate to know the fate of the Enhanced Capital Notes (ECNs) that in some cases reward them with coupons of over 10%.

While the Tier 2 notes had counted as stress test capital up until now, Lloyds said the probability of this continuing to be the case had significantly diminished.

This sent the bonds tumbling, with some issues losing as much as nine points on fears the bank could make use of a clause allowing it to call the bonds at par - well below where they have been trading - if they lose regulatory capital value.

"The tide is turning for investors," said Dierk Brandenburg, a senior bank credit analyst at Fidelity.

"In a low rate environment banks are very focused on their net interest margins and on growing share earnings and dividends. Bondholders are less important than during the crisis and shareholder interests are on the rise."

Richard Thomson, a senior credit analyst at Henderson Global Investors, added that the bank had referred to its fiduciary obligation to its shareholders on the call.

The move in Lloyds' bonds was reminiscent of what happened to a USD1.5bn hybrid Tier 1 from Credit Suisse last week when the Swiss bank made a similar announcement.

"Lloyds appeared to be talking down the bonds on purpose to manage investor expectations," Thomson added.

While Lloyds has the option to play hard ball, buying the bonds back at par and forcing bondholders to swallow a bitter pill, analysts believe this is not likely to be the case.

"Our feeling is that Lloyds considers itself bondholder friendly and would be more likely to choose some form of liability management exercise at above par but potentially below current levels," analysts at CreditSights wrote in a note on Thursday.

Meanwhile, Christy Hajiloizou, a credit analyst at Barclays, said there was a fine balance between being friendly to investors and exercising regulatory rights that were spelled out in documentation.

"Credit Suisse and others will be weighing up the unidentified cost of angering investors with aggressive regulatory calls that could be reflected in their future cost of funding," she said.

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It's easy to understand why the market is so focused on Lloyds. The bailed-out lender has some GBP8bn of ECNs that trade well above par, have regulatory calls and have double digit coupons.

Back in 2009 when Lloyds first issued ECNs, the bank was in a dire situation, and the deal helped it get back on its feet by injecting much needed capital.

But the bank is understandably weighing its options now that it has turned a profit, and given also that the notes will be unlikely to count towards stress test capital due to their 5% trigger - below the 5.5% required by the European Bank Authority for this year's tests.

While it remains to be seen what Lloyds does, it may follow Credit Suisse's path. The Swiss bank on Friday announced that it was offering to buy back its USD1.5bn hybrid Tier 1 at 103 instead of a straight call at par, offering an olive branch to investors

The bonds had been trading as high as 107 before the announcements, but plummeted to the 103 offer price.

"Credit Suisse is being pretty fair with investors but it's understandable that people are now expressing concerns about Lloyds' ECNs given they trade significantly above par and are unlikely to count as stress test capital," said Thomson.

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