With this week’s launch of the €1bn Barclays 8% 2022 Alternative Tier 1 bonds, Snowden recounts his rationale for buying into the Lloyds paper that had its share of critics at the time of launch.
Snowden, who runs the Kames Investment Grade, Investment Grade Global and Absolute Return bond funds, said in November 2009, Lloyds Banking Group completed a £20bn capital-raising to rebuild its balance sheet and avoid the Asset Protection Scheme – £13bn through an equity placing and the remaining £7bn through a bond exchange.
Those invested in Upper Tier 2 and Tier 1 bonds were offered the chance to swap those bonds for Contingent Convertible Notes, later being nicknamed CoCos.
The bonds divided opinion, recalled Snowden, yet he has calculated that over the last four years, those CoCos, with a maturity date of 2020 and a coupon of 7.869% had returned 83%, compared with 58% for the European High Yield market, 38% for the iBoxx £ Non-Gilt 7-10yr Index and 26% for Gilts also set to mature in 2020 as well.
He said: “Clearly investors who bought Lloyds CoCo bonds four years ago should be happy. To be fair to those that suffer from coulrophobia [the fear of clowns], CoCo bonds are not without risks. And one CoCo is not the same as another."
He gave his reason for making the swaps in 2009, with generous terms and remote risks.
The CoCos convert into Lloyds shares at 59p per share if the core capital ratios fall below 5%. With Lloyds shares at 77p (at time of writing), the factors to consider are the likelihood of conversion and the value of the equity at conversion.
“We can be pretty certain that the value of the equity would be low, and potentially zero. But if you get converted you still at least have the potential of some recovery.
“As for the likelihood of conversion, it is remote, mostly due to the terms and conditions of the bond. Lloyds Cocos convert to equity if core capital falls below 5%. But critically that 5% trigger level is set on an old definition. New capital requirements are more stringent. Under the modern definition, that equates to approximately 3%. Given that systematically important UK banks are not allowed to let their core capital drop below 6%, the chance of conversion is remote.”
He added that the risk was even more remote given the tougher capital requirements on banks.
The Barclays bond issued this week also converts to equity but at a core capital trigger of 7%, meaning the likelihood of conversion is higher.
The coupon terms were also restrictive, he said, compared with the Lloyds’ ‘must-pay’ security.
“We think Barclays is a fine bank and its Alternative Tier 1 Contingent Capital Note is unlikely to trigger. But the easier to trigger 7% capital level combined with the weak coupon language makes the new Barclays bond less attractive than the old Lloyds CoCos. That is why four years after being called a clown I still hold Lloyds CoCos.”
