Lloyds 9.25 Perpetuals (LLPC Pfd ISIN: GB00B3KS9W93)
We are investors in financial sector securities with a focus on Bank preferreds and Sub debt.
Lloyds 9.25 are irredeemable non-cumulative preferred shares. They are currently trading at a price of
140.5 and offer a current yield of 6.7% in GBP or 8.5% swapped into USD. Due to circumstances we
explain in this writeup, we believe Lloyds 9.25 have a price floor in the 130s. We also think Lloyds is
likely to tender for these securities at a price around 150 in early 2019, offering a total return of 15-20%
on a capital instrument from a strong issuer.
In March, a peer UK institution committed a comedy of errors which spooked the market with concerns
that these irredeemable securities were in fact callable. Despite these fears being refuted, the Lloyds
9.25s remain down nearly 20% from their early March level. As a result, we believe these securities
offer attractive risk-adjusted yield and the opportunity for capital appreciation.
On March 8th 2018 Aviva PLC alerted its investors that it could in theory, use a court sanctioned process
called a “reduction of capital” to redeem its own irredeemable preferred shares at par plus accrued
interest and arrears. Subsequently, its outstanding irredeemable preferred shares collapsed. For
example, AVLN 8.75s fell from 175 to about 120. Other irredeemable preferred shares didn’t fare much
better as fear spread that issuers would make use of this mechanism to rid themselves of these high
coupon liabilities. If employed, the reduction of capital mechanism would have relied on a simple assets > liabilities test to
upstream capital from the subsidiary to holdco, despite the “irredeemable” label on the tin. Of course,
this is not how things played out…
On the 12th of March 2018, Ecclesiastical, another issuer of irredeemable preferred shares that they had
“no plans to cancel [their own] preference shares…”, while bank issuers of these shares generally stayed
quiet. The mark to market losses in retail, pensioner and institutional accounts created an uproar in the bond
market that forced Aviva to issue a statement on the 23rd of March that they had “decided to take no
action to cancel [their] preference shares.” and would not approach this subject again until 2026, at
which point they would take “into account the fair market value of the preference shares at that time”.
However, even that was not enough and Aviva eventually had to offer a discretionary goodwill payment
to holders who sold preference shares between March 8th and March 22nd. In other words, Aviva
retroactively made sellers whole.
We do not believe this was done out of the kindness of Aviva’s heart. Rather, this was most likely necessary to forestall a full blown political crusade in the UK against Aviva.
Unlike Aviva and Ecclesiastical, none of the bank issuers made any public announcements regarding
their intentions towards the irredeemable preferred shares. After weeks of deafening silence, the FCA,
under much pressure by British MPs, sent out a letter to the banks encouraging them to publish any
updated information on the terms of and recent considerations concerning the irredeemable preferred
shares. This opened the door for the banks to comment publicly on them. Lloyds took the opportunity
and commented that they had “no plans to use a capital reduction to cancel the irredeemable
preference shares.”. In other words, Lloyds has already publicly stated that the 9.25s will remain
outstanding in the foreseeable future. We find additional comfort in the thought that, given the UK