Thousands of investors stand to lose valuable income streams after the Supreme Court ruled that Lloyds Bank (LLOY) was within its rights to redeem these bonds - and did not have to pay compensation.
This long-running legal battle surrounded the repurchase of £3.3 billion Enhanced Capital Notes (ECNs), which had paid interest rates of up to 11%.
These are effectively a type of bond, paying an enhanced interest rate. However, these credit notes could be converted into shares if the bank’s capital ratio fell to a certain level.
Many of the bondholders were retired retail investors. They had initially Pibs (or Permanent Interest Bearing Shares) from building societies, which were subsequently been subsumed into Lloyds Banking Group. This included both the Halifax and Cheltenham & Gloucester.
These Pibs were converted into ECNs in 2009 – at the height of the financial crisis. This enabled Lloyds to shore up its financial position, as these bonds could count towards its capital reserves.
However, the Prudential Regulatory Authority decided in 2014 that ECNs did not count as capital. This in effect triggered a ‘capital disqualification event’ which allowed Lloyds to buy back these bonds at ‘par’ value - the original issue price.
Prior to this forced buyback many of these bonds had been trading at much higher prices, due to the generous income streams paid.
Close Legal Battle
In 2015 the High Court found in favour of the bondholders, but this was overturned by the Appeal Court this Spring. The Supreme Court yesterday upheld the Appeal Court’s ruling, but by the slimmest margin. The decision when 3 to 2 in favour of Lloyds Bank.
A spokesman for Lloyds said: "The Group has sought to balance the interests of all stakeholders including our 2.6 million shareholders, as it takes steps to meet the requirements of the changing regulatory landscape and manage its capital requirements efficiently."
It had been estimated that the compensation bill could run to £1 billion if the Supreme Court decision had gone the other way. Lloyds share price has since climbed following this judgement.
Asim Bajwa, head of advisory at Canaccord Genuity Wealth Management, said: "This was a David and Goliath battle, but in this instance the giant won.
"The problem for the retail investors who have been hit by this ruling is that many are elderly with a low risk appetite - they were relying on this income and their living standards will be hit in many cases. It will certainly make investors considering investing in corporate bonds think twice."
Shareholders Breathe Sigh of Relief
Laith Khalaf, senior analyst at Hargreaves Lansdown said: “‘Lloyds has won the day, but it was a really close run thing. Lloyds shareholders will breathe a sigh of relief that a whole new avenue of redress has not opened up, just as the cost of PPI claims is coming to an end.
“Bondholders have basically lost out on future interest payments as a result of a shifting regulatory landscape, which encouraged the use of hybrid debt to bolster banks during the financial crisis, but has since seen new standards being set.
“The tangled web of terms and conditions the court has had to unpick demonstrates the complexity of hybrid debt securities, which is why the financial regulator has now restricted their sale to sophisticated investors only.”
These Enhanced Capital Notes issued by Lloyds in 2009, and were a form of ‘Coco’ – contingent convertible debt. In the first use of new consumer protection powers in August 2014, the Financial Conduct Authority banned the sale of Cocos to retail investors, restricting their use to professional, institutional and sophisticated investors only.
Lloyds Banking Group has a four-star rating, meaning it is an undervalued stock rated by Morningstar analysts. Shares of the bank were up 5.5% to 64.72p at 11:30 London time on Friday.
