The Court of Appeal has backed Lloyds Banking Group’s request to buy back bonds issued to investors during the financial crisis, overturning a decision by the High Court.
Three judges from the UK’s highest court unanimously ruled in favour of the bank’s request to buy back the high-interest bonds, meaning the issuers save around £200m annually over the next five years.
The bank issued the bonds, known as enhanced capital notes (ECNs), to investors in 2009 to act as a cushion in case the bank’s capital fell below what was required.
ECNs are hybrid bonds which switch into shares if the bank’s capital ratio ever fell below 5 per cent, and aimed to help banks through the ‘stress tests’ set by the regulators.
However, changes to regulation meant that ECNs could no longer be included as part of the company’s capital buffer, and were therefore not taken into account during the Prudential Regulatory Authority’s stress test in 2014.
The Financial Services Authority cited Lloyd’s shortfall in ‘core capital’ and the bank was required to take action to correct its position by increasing its core capital ratio.
Lloyds therefore decided it wanted to buy the ECNs back from investors at face value, and invoked a clause known as ‘capital disqualification’ which looks at a change in requirements set by regulators, and the intent of the requirements at the time it was set.
However, in June the High Court judge decided the issuers were not entitled to redeem the ECNs after the bank passed a stress test conducted by the PRA in December 2014, and therefore must continue to pay the interest.
Bondholders, who believe the bonds are worth more than par value, tried to stop the buyback because they were concerned they would lose out. But the High Court’s decision was thrown out.
During the Court of Appeal hearing, Lord Justice Briggs said: “I am comforted […] by the perception that it was to assist in passing, rather than merely featuring in, the stress test that the ECNs were issued in the first place, that they have now ceased to play any useful part in doing so, and are on the face of it unlikely to do so again for the foreseeable future.”
The bonds were popular among investors for the high interest they paid, with the bank issuing £8.3bn of ECNs in December 2009. Of these, around £5bn have recently been exchanged for other instruments.
About £3.3bn remain in issue in their original form, with maturity dates ranging from 2019 to 2032 when the issuers are required to repay the capital amounts of the ECNs.
Until then, interest is payable on the ECNs at an average rate of 10.33 per cent, and some have an interest rate as high at 16 per cent.
The bonds are held by a large number of retail investors, as well as by institutional investors.
katherine.denham@ft.com
