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Lloyds (LLOY) bondholders will lose out on income after the Supreme Court sided with the bank the redemption of its bonds.
Thousands of investors will see their income cut after the Supreme Court ruled Lloyds was allowed to redeem high-interest paying bonds following a lengthy legal battle.
The Supreme Court ruled said the bank was within its rights to stop payments and redeem the 'enhanced capital notes', some of which pay generous yields of up to 11%. The ruling means investors, many of which are pensioners, will not be liable to compensation from Lloyds to cover the income they have lost.
Bondholders lost by a whisker on a 3-2 vote in Lloyds’ favour.
Mark Taber, a fixed income expert who has been helping the bondholders, said the ruling raised ‘further massive issues over the role of the regulator’ in the bond battle. He argued it posed questions over whether the Financial Conduct Authority (FCA) failed in its duty to ensure bondholders were properly informed about their investment.
He said the judgment made ‘no reference to the arguments made in court over the statutory requirements that [the bond] prospectus should be accurate and contain all the information investors need to make an informed decision’.
‘If the courts will not consider these statutory requirements in interpreting prospectuses then it must fall on the FCA,’ he said.
Taber said he believed both Lloyds and the FCA were aware that capital requirements for banks were due to change when the bonds were issued, meaning they knew that the small print in the bond prospectus could be enforced - because a ‘capital disqualification event’ would occur - and the bonds redeemed.
‘I believe the changes they knew about, which were not disclosed in the ECN prospectus, meant that, under Lloyds' claimed intention, a capital disqualification event was a certainty at the time the ECNs were issued,’ said Taber.
‘If the court had been told this I think it would have made a difference.’
Lloyds said in a statement: ‘Throughout this process, 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.’
The bad news for bondholders would be a relief for Lloyds shareholders, said Hargreaves Lansdown senior analyst Laith Khalaf.
‘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 payment protection insurance claims is coming to an end,’ he said.
‘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.’
Khalaf said the court case highlighted the ‘tangled web of terms and conditions’ of ‘hybrid debt securities’, the sale of which has now been restricted to ‘sophisticated investors’.
The ECNs started life as permanent interest bearing shares (Pibs), a type of bond that were converted by the bank in 2009 when it urgently needed to boost its regulatory capital.
However, the problem arose over whether a ‘capital disqualification event’ (CDE) occurred that would allow the bank to buy back the bonds, which pay interest rates of up to 11% and are an expensive form of debt for Lloyds to service.
Lloyds argued that a CDE occurred last year when the Prudential Regulatory Authority (PRA) stress-tested the bank to see if it could withstand another crash but it did not include the ECNs as part of its reserves.
The High Court then ruled a CDE had not taken place as the regulator could include the bonds in a future stress test. Lloyds argued that it had made a mistake and had meant to insert a clause for a CDE into its contract that would have been triggered if regulators raised the amount of ‘tier one’ capital it had to set aside to above 5%.
At the time the Pibs were converted to ECNs the requirement was for 4% of capital, meaning the 5% trigger would have been easily reached as regulators forced banks to strengthen their balance sheets in response to the credit crunch.
Bondholders argued they had not been told about the 4% figure and that if they had, they would not have switched their Pibs to ECNs.