Lloyds bond battle ends badly for investors

Lloyds Bank has announced that it will redeem £3bn-worth of bonds known as enhanced capital notes (ECNs) on 9 February. The decision comes after more than a year of legal battles with the bondholders, who argue that Lloyds does not have the right to redeem the bonds. Given that the investors might still be able to take their case to the Supreme Court, Lloyds’ action has been criticised as premature. The bank says it will compensate bondholders if the court ultimately rules against it.

The affected investors, including many pensioners who rely on the bonds for income, are those who bought bonds called permanent interest-bearing shares (Pibs). These had been issued by building societies that were subsequently taken over by Lloyds. During the financial crisis, Lloyds needed to raise fresh capital and asked holders of Pibs to swap them for a different type of bond – the ECN.

These could be converted into shares under certain circumstances and thus helped to improve the bank’s capital ratio. Subsequent regulatory changes meant that ECNs no longer served the same purpose, so last year Lloyds announced that it would redeem the bonds. From a business point of view, this makes sense: the interest rates on the bonds are far higher than rates on bonds issued today, hence redeeming them could save Lloyds a significant amount in interest over the life of the bonds (up to £900m, says Emma Dunkley in the Financial Times).

Unsurprisingly, bondholders were angered by the announcement – not least because they felt that they had done the bank a favour by agreeing to this exchange when Lloyds was struggling. More importantly, they believed the redemption was not consistent with the contractual terms of the bonds, so they sued to prevent it.

The bondholders won in the High Court, but the decision was overturned in December 2015 by the Court of Appeal, with Lloyds claiming that wording in the prospectus that favoured the bondholders was a drafting mistake. The bondholders are now seeking leave to appeal to the Supreme Court and are unhappy that Lloyds is unwilling to defer redemption until all appeals are finished.

Bondholders have also criticised the Financial Standards Authority (FSA), the UK regulator that oversaw the exchange, and its successor agencies, the Prudential Regulation Authority and the Financial Conduct Authority, for failing to protect investors. And certainly, regardless of whether Lloyds has the right to redeem the bonds, there are serious questions over how unsophisticated retail investors were encouraged to swap Pibs for ECNs that had such unclear, disadvantageous terms.