Lloyds, which is partly owned by the taxpayer, will pay a dividend for the full year for 2014 for the first time since 2008, when it was bailed out by the Government due its near-collapse as the financial crisis unfolded.
“Since those dire times, the bank has recovered thanks largely to backing from retail and institutional investors. Therefore the story goes that it now seems fair to reward long-term supporters of the bank when times have improved, right?” Pelteshki said.
However, he points that holders of the £13% Perp Callable in 2029 bond are still owed cash dating back to 2011 and 2012 because the bank was under a two-year European Union ban on paying dividends and coupons on certain bonds.
Lloyds debt has suffered over the past few years, losing money in all denominations, according to FE Analytics and shown in the graph below.
Performance of Lloyds’ bonds over 2yrs
Source: FE Analytics
Since the ban on dividends and coupons was lifted, Lloyds has resumed coupon payments on the 13% bond. However, two skipped coupons have still not been paid, according to Kames.
“Legally speaking, the coupon on the £13% notes is fully discretionary and can be deferred (still cumulative) until the call date in 2029,” Pelteshki said.
“However, in practice, the bonds were sold to UK investors with the implicit understanding that punitive clauses like a coupon deferral were only required for regulatory purposes and would not be invoked unless the firm had a real economic need.”
“Given that Lloyds has made obvious steps towards recovery and is applying for permission to pay dividends, economic need is now hard to justify.”
“Ignoring the fact the UK Treasury is still the largest shareholder of the bank (thereby the largest beneficiary from a cash payment just ahead of the general elections in May), distributing dividends while bondholders are still owed goes back to the age old agency problem between shareholders and creditors on compensating the former before the latter.”
The manager warns this could inadvertently hurt Lloyds and its shareholders if it means the firm has to pay more its future borrowing.
“A company’s management may often prioritise shareholder interest over that of the primary bondholders for various reasons. Doing so it walks a very fine line as this could inadvertently raise the overall cost of funding for the firm if debt holders feel sufficiently alienated.”
Lloyds lost almost 90 per cent of its value between September 2007 and March 2009, when equity markets broadly bottomed out, but has since recovered some ground. However, its share price is still just a third of its pre-crisis high.
Performance of index since 2007
Source: FE Analytics
The bond is held by both the Kames Sterling Corporate Bond and Kames Investment Grade Bond funds as top 10 positions.
TwentyFour’s John Magrath is equally scathing of the decision, although as a house TwentyFour is not a holder of Lloyds’ debt.
“Lloyds continues to make noises about the ineligibility of these bonds for stress testing and therefore claiming the right to call,” he said.
Magrath says this should make investors nervous: “While we think it is unlikely that all the bonds are called, we think some probably will be to avoid being accused of manipulating the market, and of course they said that they might already.”
“Investors still holding Enhanced Capital Notes today should be considering their options right now, as I can’t see the bond prices being the same in a few days’ time – they could also be higher … but with Lloyds’ previous form I would not bet on it.”
While Lloyds’ debt is somewhat less popular, its equity has shot up in popularity, according to Laith Khalaf, senior analyst at Hargreaves Lansdown.
One in five UK income managers now hold Lloyds in their fund and the stock is the favourite bank share with retail investors.
“The banking sector still represents a large chunk of the UK stock market, so it is natural to find banking stocks in the portfolios of professional fund managers and DIY investors alike,” Khalaf said.
“However the banks are still tainted in many investors’ minds by the financial crisis, not to mention PPI mis-selling, the LIBOR rigging scandal, and most recently claims of allegedly aiding and abetting tax evasion.”
“Nonetheless the next two weeks of bank results are likely to bear witness to a sector that is trying to get back to business as usual. Lloyds, which hasn’t paid a dividend since 2008, is expected to announce a small payment to investors as a taste of things to come.”
“While the UK banks appear to be getting back to health however, there still remains the risk of skeletons coming out of the closet, as the recent tax evasion row shows, and the regulatory fines the banks may yet face for their past misdemeanours loom large.”