Lloyds faces charges over enhanced capital note bonds

Thousands of Lloyds investors, who have been paying up to 16% interest on enhanced capital note bonds bought from the bank amid the financial crash, are waiting upon a court ruling, which is due today, to decide whether Lloyds is within its rights to buy the bonds back at face value price. If the investors are successful in court, Lloyds may be forced to pay compensation to the affected parties despite including a condition in the terms of the bonds stating they could be repurchased at the original price, not their secondary market price. However, if Lloyds wins, a poor precedent will be set for bondholders' right generally, placing the bank in a no-win situation.
Ruling handed down: Supreme Court said Lloyds was within its rights to buy back its bonds at face value

Thousands of investors who bought special Lloyds bonds paying interest at up to 16 per cent can be forced to sell them back to the bank at face value, the Supreme Court has ruled

A legal battle has raged for several years over the 'enhanced capital note' bonds - first created when the bank was trying to shore up its finances in 2009 - which Lloyds repurchased for just above their original 100p price earlier this year.

The Supreme Court ruled today that the bank was within its rights to redeem them under the terms of the original bond deal, dashing the hopes of investors who would have been in line for compensation if the decision had gone the other way.

So what is the dispute about and what might be the fallout for other bond investors?

What type of bond is involved?

The Lloyds ECN bonds are a form of corporate bond, which at their simplest are IOUs issued by companies and bought by investors for a fixed term.

Interest is paid to the holder until maturity, when the original money is repaid, so long as all goes well and the company doesn't go bust.

In the meantime, bonds can be bought and sold on a secondary market at prices which might be above or below what was first paid. Read more here about how corporate bonds work.

The special series of Lloyds bonds in this case were issued after the financial crisis to bolster the bank's balance sheet. It offered attractive interest rates, ranging between 6 per cent and 16 per cent, for terms of 15 years.

The bonds were 'convertible' into shares under certain circumstances. This means they were a type of 'contingent convertible bond' or CoCo, which regulators have since decided should not be sold to ordinary investors due to their complexity.

Why is there controversy over these Lloyds bonds?

Lloyds included in the terms of the bonds a condition that they could be repurchased at the original price - not their price on the secondary market - if a 'Capital Disqualification Event' occurred.

This is highly technical but it's all about whether they count as part of the bank's core capital - its buffer against things going wrong - or not.

Legal battle: Lloyds wanted to redeem its 'enhanced capital note' bonds, first created when the bank was trying to shore up its finances in 2009,

The bonds first sold for 100p but went on to trade for much more on the secondary market at times, so they became worth a lot more in price as well as offering a tidy interest rate.

Lloyds began to launch 'tender offers' where it bought back some of the bonds for more than 100p from investors.

But then, in early 2015, it declared a Capital Disqualification Event after a round of stress tests where Bank of England officials excluded the bonds from Lloyds' eligible core capital.

That meant anyone still left holding the bonds might only get 100p and also lose future interest payments.

What happened when bondholders launched legal action?

A legal case was launched which revolves around the wording of the bond prospectus regarding the triggering of a CDE.

A group spearheaded by investor Mark Taber fought Lloyds' attempt to redeem its bonds and won in the High Court in June 2015, but lost in the Court of Appeal last December.

LLoyds began buying back its bonds for just above 100p earlier this year, ahead of the case going to the Supreme Court, but said at the time it would compensate bondholders fairly if it lost.

After today's ruling, a Lloyds Banking Group spokesperson said: 'The group welcomes the Supreme Court’s decision.Throughout this process, the group has sought to balance the interests of all stakeholders including our 2.6million shareholders, as it takes steps to meet the requirements of the changing regulatory landscape and manage its capital requirements efficiently.'

What was at stake in this case - and what might it mean for other bondholders?

'Today is a sad day for the rights of bond holders. It was a David and Goliath battle, but in this instance, the giant won,' said Asim Bajwa, investment director at Canaccord Genuity Wealth Management.

Asim Bajwa: 'Today is a sad day for the rights of bond holders. It 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.'

Bajwa said Lloyds had claimed the definition of core equity may change over time and retail investors reasonably ought to know that.

He arguesd this was wrong on the grounds that the Lloyds' ECN bonds were technically still part of any stress tests, as all bank capital is essentially at risk when things go wrong, so they were not disqualified as capital and shouldn't be paid back at 100p.

Jason Hollands, managing director of financial services firm Bestinvest, said: 'This debacle does highlight the risks that retail investors face when investing directly in bonds, as opposed to through funds, where complexities and issues can arise due to where a bond sits within an issuer's capital structure and regulatory issues which can be very technical.

'This is especially in the case of a complicated, hybrid investment structure such as a CoCo bond where the Financial Conduct Authority has rightly introduced restrictions on their distribution to retail investors.

'The vast majority of retail investors should achieve their exposure to bonds through professionally managed, diversified funds.