Thursday, 20 September 2018

Contingency plans

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It has been a busy year for Lloyds Banking Group, now majority-owned by the UK state, against a backdrop of uncertain and sometimes volatile markets. It has borrowed across currencies and in various asset classes, pioneering relatively untested products one month, before tapping tried and tested markets the next. It has also acted decisively to address investor concerns about some of its problem structured finance vehicles. Helen Wray and Philip Wright report.

While Lloyds was as busy as any other borrower within the government-guaranteed sector, it also launched a number of senior unsecured benchmark trades that re-established its standalone credentials – when the market allowed. But its most eye-catching exercise was the exchange of existing Tier 1 and Upper Tier 2 securities for new Enhanced Capital Notes, so-called contingent capital, completed in November 2009.

Although the ECNs were issued in LT2 format, they are treated by the FSA as core Tier 1 for stress purposes. They carry bullet maturities of between 10 and 15 years and feature non-deferrable coupons. That proved popular with investors, the coupons on the majority of the existing securities being subject to deferral or suspension for a two-year period from January 31 2010, at the behest of the European Commission. The exercise of call options was also embargoed.

There is a trigger event that sees them convert into ordinary Lloyds shares if the group’s published core Tier 1 ratio falls below 5% – a figure deemed more appropriate than the 4% originally discussed because the numbers are produced on a look-back basis.

The aim was to exchange a maximum of £9bn of securities, although a total of 58 instruments with an aggregate amount of £16.5bn were earmarked. There were 52 in a non-US offer (£14.3bn) and six in a US offer (£2.2bn). The take-up was high, at in excess of 80% on the former and around 75% on the latter. The final bond to be accepted in full in the waterfall priority list was number 30, number 31 being pro rated at 0.1053381.

When combined with the £13.5bn rights issue that accompanied it, the initiative notched up a number of records. It was the largest-ever financing package in UK corporate history, the largest fully underwritten capital-raising in Europe and the first ever combined rights issue and exchange offer. The deal was led by global co-ordinators Bank of America Merrill Lynch and UBS, with Citigroup, Goldman Sachs, HSBC and JP Morgan Cazenove as dealer-managers.

Its structured finance activities have also aroused considerable attention. In September 2009 Lloyds partially placed the £4bn UK prime RMBS Permanent 2009-1. The sterling A-2 tranche priced at three-month Libor plus 180bp, while the euro A-3 piece printed at three-month Euribor plus 170bp.

It reopened the European securitisation market at the start of 2010 with its Reg S/144a Permanent 2010-1 UK RMBS, through joint leads Lloyds TSB, Bank of America Merrill Lynch and JP Morgan. The £2.3bn-equivalent deal came in sterling and euros, but was supplemented with a 2.95-year WAL US dollar piece – a first in the post-crisis European primary world. That piece was doubled from an initial US$500m and priced in line with guidance at three-month Libor plus 115bp.

It was backed by the £38.9bn Permanent master trust portfolio of prime UK mortgage loans originated by the Bank of Scotland’s Halifax unit. The 470,824 loans featured a weighted average indexed LTV of 65.78% and a weighted average seasoning of 54 months.

“US investors viewed the master trust structure as a positive because it means there is a strong backing from the sponsor,” said Robert Plehn, head of structured securitisation at Lloyds Banking Group.

In April Lloyds Banking Group’s Arkle 2010-1 RMBS launched and priced what at the time was the largest distributed RMBS since the collapse of Lehman Brothers. The US$500m equivalent 1A short one-year money market piece priced in line with guidance at 20bp over Libor, offering US investors an attractive pick-up to what they can achieve domestically. But more notable was the US$1.85bn, 2.8-year 2A portion, which was significantly upsized from just £500m, yet still priced in line with guidance, at three-month Libor plus 115bp.

With 61% distributed in the US, the transaction demonstrated increased demand for UK RMBS product from US investors. They were probably also lulled by a hefty credit enhancement: the Class A notes featured a fat 13.29% cushion of subordination, which was more than double the 6.5% featured in the Sequola Mortgage Trust 2010-H1, which priced a week earlier.

Despite ongoing concerns around the risk of maturity extension, the deals have gone some way towards assuaging investor concerns about the vehicles, ensured maturity redemptions will be met.

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