UPDATE 3-Lloyds offers investors deal to swap bonds, cash out

Thu Mar 6, 2014 12:34pm EST

* Lloyds to swap up to £5 bln of bonds from institutions

* Bank offers to cash to retail investors for their bonds

* Bonds helped save Lloyds in 2009, but capital rules have shifted

* Lloyds to take £1 bln charge, saves on interest payments

By Aimee Donnellan and Steve Slater

LONDON, March 6 (IFR) - Lloyds Banking Group is offering bondholders who helped rescue it five years ago the chance to swap their holdings into new debt or cash out now in case the bonds get called at par.

Faced with investor outcry after saying last month it could buy back £8.4 billion ($14 billion) of bonds at face value under new capital rules, Lloyds held out an olive branch Thursday.

The lender is offering institutional investors the chance to swap up to £5 billion of their bonds for the new instruments in euro, dollars and sterling. Retail holders are being offered cash.

Britain's financial regulator encouraged Lloyds to offer retail investors cash as a way to exit, as the watchdog is keen for the general public not to hold complex instruments, people familiar with the matter said. The Financial Conduct Authority declined to comment.

New European banking regulations mean the existing bonds are unlikely to count toward capital buffers - and under the terms of sale, that would allow Lloyds to call them at face value.

But the bank, which is still 33% owned by UK taxpayers, met with a furious reaction when it surprised investors last month by saying it might do so.

Mark Taber, a campaigner for retail bondholders, last week wrote to Lloyds calling the move "irresponsible and short-termist".

Instead, the new proposal gives the bank's 120,000 retail investors the chance to cash out - a move that also offers Lloyds a way to avoid hurting its chances for raising funds in future.

"This is a very Lloyds-like deal," Neil Williamson, head of EMEA credit research at Aberdeen Asset Management, told IFR.

"It is not a giveaway, nor are they invoking all their contractual rights. They could have called the bonds at par but instead they are using the potential regulatory call at par as a stick for the future, while giving investors a chance to get out."

COMING TO TERMS

The existing bonds, known as enhanced capital notes (ECNs), are now seen as relatively low risk instruments, with an attractive annual interest of 6%-16%.

They had been trading at a premium, but their value fell up to nine points after last month's warning from the bank.

The bonds rallied as much as four points Thursday after the exchange offer was announced.

Now 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 ECNs only convert if core capital falls below 5%.

Lloyds 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 basis points off its Common Equity Tier 1 ratio.

But it will save money from lower future interest payments, which it said would boost 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 - a savings of more than £150 million a year.

FAIR OR NOT?

Lloyds said the offers was made at "a price consistent with current trading prices," although many of those prices have fallen in the last three weeks.

Retail investors are being offered premiums of 6-14% on most of the bonds.

"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, the campaigner, said on Thursday.

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

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

Despite the riskier elements of these trades, though, investors 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.

Lloyds has hired a large team of banks to assist; they are Bank of America Merrill Lynch, Lloyds, Goldman Sachs, Barclays, Morgan Stanley Deutsche Bank and UBS, Barclays, BNP Paribas, Citigroup, Credit Agricole CIB, Credit Suisse, HSBC, JP Morgan and Morgan Stanley on the dollar.

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