On some tickers, Lloyds Banking Group PLC (LON: LLOY) is up 45% this morning. This is not, sadly, the grand victory for long-suffering shareholders that we might hope. This is a technical issue to do with the ADRs representing the preference shares.
Just to unravel that. The capital base of a major bank these days is complex. It’s not as simple as just the equity – like the common shares of Lloyds Bank say – then topped up with some debt. The exigencies of the regulatory system have led to a mixture of instruments each having certain debt-like and equity-like attributes. Which is the best for the bank to issue at any one time depends upon the precise reading of those regulations. Some things which are a little more debt-like will be counted as major – Tier 1 – capital and then they won’t be as tastes and regulations change.
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The real background here is the near-collapse of all the banks in 2008, 2009. It was obvious that the banks needed to have larger capital buffers or they’d need to be between supported – like Lloyds was – near taken over – like RBS – or closed down – like Northern Rock.
However, the definition of what was capital changed over time. Permanent bonds were at one time that Tier 1 capital which supported the banking business. Preference shares, which are bond-like in that they pay a fixed coupon, but equity-like in that it can be stopped and the capital is at risk, are more obvious capital rather than debt.
The thing being that fashions among banking regulators change over what is to be considered to be that Tier 1 capital. The different instruments also have different prices to the issuer. Different coupons to be paid given the levels of risk and so on. What is the most appropriate, or efficient, capital structure between the different instruments therefore changes over time.
It is also true that outside prices change, Interest rates are a lot lower today than they were in the past, certainly than they were 15 years ago, So, the mix between issuing a bond with a fixed coupon at today’s rates and an old one paying the higher coupon of the past can change too.
All of this being the necessary background to understanding why some Lloyds instruments are being recorded as having jumped 35 to 45% overnight.
Lloyds Bank tendered for the repayment or replacement of certain preference share issues. A guide to the pricing terms of the Lloyds offer is here. Such things as the Lloyds 6.4% preference shares, the 6% subordinated notes, would be exchanged for a mixture of cash and new notes at different coupons. The success of the Lloyds offer is detailed here. Given those high coupons the exchange prices were at well above par.
This then gets one stage more complex, in that these are USD instruments, traded in the US as American Depositary Receipts, or ADRs. It is the price of those ADRs which has jumped by, variously, 35 and 45%.
It’s all a useful clean up of the capital structure of Lloyds Banking Group but despite the tickers showing those vast price jumps it’s of no great importance to the actual share price. Sadly.