REFILE-UPDATE 2-Lloyds offers bondholders olive branch with cash, exchange offer

Thu Mar 6, 2014 9:18am EST

By Aimee Donnellan and Steve Slater

LONDON, March 6 (IFR) - Lloyds Banking Group is offering bondholders who helped rescue the bank five years ago the chance to swap into new debt that meets capital rules, and is giving thousands of retail investors the chance to cash in their holdings.

Lloyds, 33% owned by the UK taxpayer, said on Thursday it was making the massive bond exchange and repurchase offer to align its capital base with new European rules, and to give investors the chance to reduce uncertainty around their holdings.

The lender is offering institutional investors the chance to swap up to £5 billion of their bonds for the new instruments. Retail investors are being offered cash to motivate them to exit.

Lloyds surprised investors last month when it said it could buy back at face value £8.4 billion ($14 billion) of bonds it issued to strengthen its capital in 2009, because new European rules mean they are now unlikely to count towards its capital buffers.

The instruments, known as enhanced capital notes (ECNs), look relatively low risk against the current market backdrop and pay high annual interest of between 6% and 16%, so are an attractive investment. Hedge funds and asset managers are big holders of the bonds, but there are also up to 130,000 retail investors.

The bonds had traded at a substantial premium to their issue price, but their value fell by as much as nine points after last month's warning from Lloyds. Once the exchange was announced the securities recovered some of those losses, rallying by as much as four points on Thursday.

For Lloyds, the new rules could make them worthless in bolstering its capital if the bank hits trouble. Under the terms of their sale, that would allow it to buy them back at face value.

It is offering to swap them for new additional Tier 1 instruments that will convert into Lloyds shares if the bank's common equity Tier 1 ratio falls below 7%. The current ECNs only convert if core capital falls below 5%.

BALANCE SHEET IMPACT

Lloyds said it will take an accounting charge of about £1 billion in the first half of this year, based on a full take-up of the offer. That would knock 0.4 percentage points off its common equity Tier 1 ratio.

But the bank will save money from lower future interest payments, which it said would boost its net interest margin by 5 basis points this year.

It will pay annual interest of between 6.375% and 7.875% on the new bonds, compared to an average coupon of 9.3% on the ECNs.

Lloyds said the offer to institutions and retail investors was being made at "a price consistent with current trading prices," although many of those prices have fallen in the last three weeks.

Mark Taber, a campaigner for retail bondholders, last week wrote to Lloyds urging a fair deal and saying it would be "irresponsible and short-termist" of the bank to say it could buy back the bonds at their face value.

"The cash offers look a bit low on some of them, which when combined with the implied threat to try and scare you, people will feel there's a bit of bully boy stuff going on here I think," Taber said on Thursday.

"This is basically an offer a bank makes just before they stick the knife in," a banker said.

Additional Tier 1 bonds are first in the line of fire if Lloyds runs into difficulty, which could lead to coupon deferrals on the perpetual instruments.

Despite the riskier elements of these trades, investors from around the globe have been scrambling to buy similar deals from the likes of Nationwide and Barclays.

Lloyds, which last month reported a profit for the first time in three years, is not the first bank to harden its stance on high-interest paying bonds that may no longer have any use in bolstering capital. Credit Suisse last month fired a similar warning shot.

Banks can save annual interest costs, but upsetting bondholders could prove damaging for future fundraising.

Due to the mammoth scale of the task Lloyds has hired a team of banks to assist, with Bank of America Merrill Lynch, Lloyds and Goldman Sachs taking the top line as global coordinators for euro and sterling offers, Deutsche Bank and UBS acting as joint-lead dealer managers, and Barclays, BNP Paribas, Citigroup, Credit Agricole CIB, Credit Suisse, HSBC, JP Morgan and Morgan Stanley acting as joint dealer managers.

On the dollar transaction, Bank of America Merrill Lynch and Goldman Sachs are global coordinators. Barclays, Lloyds and Morgan Stanley are joint lead dealer managers while BNP Paribas, Citigroup, Deutsche Bank, HSBC, JP Morgan and UBS are joint dealer managers.

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