Lloyds Should Boost Capital With Debt Exchange, Hohn Says
Lloyds Banking Group Plc (LLOY), Britain’s second biggest publicly owned lender, should boost capital by exchanging some of its debt securities for common equity, hedge fund Children’s Investment Fund Management LLP said.
Lloyds’s Enhanced Capital Notes shouldn’t count toward core capital because the threshold at which they convert into equity is too low, Christopher Hohn, managing partner of London-based TCI, wrote in a June 14 letter to Andrew Bailey, head of U.K. banking supervision at the Financial Services Authority. Lloyds should replace the notes with 10 billion pounds ($16 billion) of equity, he said.
“The existing securities have such a low strike price that they are unlikely to be converted into equity and so do not serve as primary loss-absorbing capital,” Hohn wrote in the letter, a copy of which the firm sent to Bloomberg. “It would need Lloyds to suffer a 20 billion-pound post-tax loss before the FSA could force the company to issue equity.”
The fund called on the regulator to disallow the ECNs or risk damaging the FSA’s reputation and the economy by allowing an “under-capitalized U.K. banking system to remain unchallenged and uncorrected.” The U.K. owns about 40 percent of the London-based lender after Lloyds sought a bailout in 2008. TCI successfully pushed in 2007 for the break-up of ABN Amro Holding NV, sparking the biggest takeover battle in the financial-services industry.
“The U.K. government, as both effective regulator and controlling shareholder, is conflicted in this issue,” Hohn wrote in the letter, a copy of which the firm sent to Bloomberg. “What is needed is for the FSA to act independently of the government and force much more common equity capital into Lloyds by disallowing the ECNs as valid capital and insisting the government replaces them with common equity.”
Lloyds spokeswoman Nicole Sharp declined to comment on the contents of the letter. Officials at TCI declined to comment on the firm’s interests in Lloyds. The stock fell 3.6 percent to 30.16 pence in London trading today, its steepest drop in three weeks.
Lloyds’s so-called Enhanced Capital Notes convert into equity should the bank’s core Tier 1 capital ratio fall below 5 percent under Basel II rules, a feature that allows them to be treated as core capital for regulatory purposes. Under the stricter Basel III rules that trigger would fall to 2 percent, Hohn said.
“Legally these securities cannot be coerced into such an exchange offer, so it must be done on commercially appropriate terms,” Hohn wrote. “Shareholders would benefit because the new bank would have a much higher equity capital base of 10 billion pounds,” he said.
The U.K. Treasury said last week that banks should have more than 10 percent of risk-weighted assets in core capital, with an additional 7 percent buffer including loss-absorbing debt. Under the Basel III rules, Lloyds has a core Tier 1 ratio of just seven percent, Hohn said.
Lloyds’s core Tier 1 ratio, a measure of financial strength, climbed to 11 percent in the first quarter, from 10 percent in the year-earlier period, Lloyds said on May 1.
TCI also said that the Enhanced Capital Notes’ average 12 percent yield-to-maturity made them an “extremely expensive” form of capital that discourage the bank from lending.
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