Over 100,000 people who bought bonds from building societies taken over by Lloyds Banking Group have lost their claim to be compensated when the bank forced them to sell.
Q. What was the court case about?
A. A group of investors took action against Lloyds Banking Group after the bank wanted to buy back a type of bond that the investors had bought from Halifax building society (before it became a bank) and Cheltenham and Gloucester.
Lloyds Banking Group wanted to force the bondholders to sell their bonds back to the bank, without compensating them for interest they would lose. The case had gone to the High Court and last week went to the Supreme Court.
SAVVY TIP: A bond is an IOU for a loan. If you buy a bond, you lend a company or government some money in return for interest.
Q. Why did the bondholders fight the action by Lloyds?
A. I warn you that there’s a lot of jargon involved, but the principle behind what’s happened is not complicated and is worth understanding.
The bondholders originally bought something called permanent interest bearing shares or PIBS, which are issued by building societies as a way of raising money. Unlike banks, building societies can’t issue shares to raise money and this is an alternative.
SAVVY TIP: Ordinary bonds normally run for a fixed term. That means they have to be repaid on a particular date. PIBS run indefinitely and tend to pay a higher interest rate as a result. You can read more about PIBs in my article called What are permanent interest bearing shares or PIBs?
Crucially, in certain circumstances, PIBs can be converted into something else by the building society that issued them (or the financial institution that owns them). In 2009, Lloyds Bank converted these PIBs to enhanced capital notes (ECNs) as part of its attempts to raise money after the financial crash. Unlike PIBs , these could be included as part of Lloyds’ capital reserves (money that banks have to set aside to comply with regulations).
In 2014, the new regulator (the Prudential Regulation Authority) assessed the banks’ ability to withstand difficult economic times (a so-called ‘stress test’) and did not include the enhanced capital notes when assessing Lloyds Bank’s capital reserves. Lloyds Bank therefore said that, under the rules, it was within its rights to force the bondholders to sell their bonds back to the bank at the same price that they were issued.
SAVVY TIP: The price that a bond is issued at is called the ‘par value’. If a bond is sold below par, it’s sold at less than the issuing price and if it’s above par it’s higher than the issuing price.
The investors said that if Lloyds Bank wanted to buy back the bonds, it should pay them more than they bought the bonds for, to compensate them for the fact they wouldn’t receive interest in the future. The interest rates on these bonds was much better than anything you could invest in now (with a similar level of risk) – paying over 10% and up to 15%.
Q. What does this mean for Lloyds and the bond investors?
A. The fact that the Supreme Court ruling went in Lloyds Bank’s favour (by a three to two majority) means that Lloyds Bank gets to save lots of money – almost £200 million a year in interest payments over four years. All it has to do is to pay the bondholders the face value of their investment. The bondholders campaign group said that the conditions were not mentioned in the prospectus when investors bought these ECNs as part of the bail out of Lloyds Bank in 2009. Although most of the money to bail out Lloyds Banking Group came from taxpayers, around 120,000 retail investors bought these enhanced capital notes.
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