Earlier this year Santander became the first bank not to call its Additional Tier 1 (AT1 or ‘CoCo’) bonds at the first call date. Markets actually took the non-call well in their stride, since the fact Santander would treat each call on purely economic terms had been well flagged. In addition, the fact that the non-called bonds were callable every three months by the borrower meant that they would not trade at too much of a discount, especially in a buoyant market.
While Santander was the odds-on favourite to win the dubious prize of first non-caller, the race for second is going to be much closer to…call. Lloyds Bank appears to be edging ahead with its £1.48bn 7% perpetual AT1, which is redeemable for the first time on June 27. Crucially though Lloyds must give a minimum of 30 days’ notice if it wishes to exercise its right to redeem early, making next Tuesday (May 28) the effective deadline. If the bank doesn’t do so, the bond’s coupon will reset to five-year swaps plus 5.06% (making the new coupon 6.15% at current rates for another five-year period), and unlike the Santander bond, the Lloyds bond will only be callable again in five years’ time.
Lloyds had always been in the back of our minds as a borrower that might take a more opportunistic approach with their AT1s, since they were originally issued in a coercive exchange. For those that don’t remember, Lloyds had a series of perpetual enhanced capital notes (ECNs) issued during the credit crisis, which it felt could be redeemed early once it became clear they would no longer count as capital under new regulations. Many retail bondholders had purchased these notes at premium prices to obtain generous yields, but Lloyds successfully argued in the courts that it had the right to call. Some notes were called, but others for institutional holders were somewhat coercively converted into new AT1 securities. The first of these to reach their first call date are the 7% bonds, while the following securities were also issued as a consequence of the conversion from ECNs:-
€750mm of 6.375% bonds callable in June 2020
£1.49bn of 7.625% bonds callable in June 2023
$1.675bn of 7.5% bonds callable in June 2024
£750mm of 7.875% bonds callable in June 2029
While we wait for confirmation on whether Lloyds will call or extend the 7% bonds we think it is strange the issuer would not seek to inform the market at the earliest opportunity of its intention regarding the call, rather than leave it to the last minute. Lloyds’ reputation with both retail and institutional borrowers was severely tarnished as a consequence of the ECN debacle, so this might have been an opportunity to try and wipe the slate clean. Having not taken this opportunity, we suspect the bank may wish to follow a more opportunistic policy going forward with these securities.
As far as the 7% securities are concerned, we do not see a big movement in price ahead in the event of a non-call, as a fresh issue from Lloyds would trade at quite similar levels to the new reset. However, in the long term we think this approach will result in more expensive funding for the borrowers that do not call at the first call date in good economic conditions, as the market will price their debt with an additional uncertainty premium.