Lloyds lambasted for lack of loyalty

Kames Capital’s fixed income manager Alexander Pelteshki has questioned whether it is appropriate for Lloyds Bank’ to restart dividend payments when it has still not made good with bondholders on skipped coupon payments.
 
Pelteshki explains that Lloyds Bank, which is still partially state-owned, recently submitted a request to the Bank of England to pay a Full Year 2014 dividend, for the first time since 2008, when it was bailed out by the UK Government due to self-inflicted financial wounds.
 
He says: ‘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?’
 
However he points out the caveat here is that a subset of those supporters, the £13% Perp Callable in 2029 bondholders, are still owed money dating back to the gloomy 2011 and 2012, when, due to Government support Lloyds was under a two year European Union ban on paying dividends and coupons on certain subordinated instruments, such as these bonds. Since the ban was lifted, Lloyds has resumed coupon payments on the 13% bond; however two skipped coupons have still not been paid.
 
Pelteshki continues: ‘Legally speaking, the coupon on the £13% notes is fully discretionary and can be deferred (still cumulative) until the call date in 2029. 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.’
 
Pelteshki continues: ‘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. Economic logic implies that debtors should be repaid the money they are owed first before shareholders are rewarded with any excess profits. This is because creditors (bondholders) have the primary claim on part of a firm’s earnings in the form of interest payments, while owners (shareholders) are paid from any excess earnings remaining. The opposite is akin to beefing up your luxury budget instead of making those credit card payments when they are due. Or buying jewellery with money you borrowed but didn’t pay back on time. Or subsidising dividends with debt!’
 
‘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. Whether this would be the case with Lloyds if the coupon issue persists is debatable. What is certain is that such actions will set a very good example of a bank looking after its shareholders at the expense of creditors.