Lloyds Banking Group

The light at the end of the escape tunnel is getting brighter. The range of schemes used by Eric Daniels, chief executive, to dig Lloyds Banking Group out of the government’s boot camp is gaining traction. At £9bn, investor take-up of the UK bank’s bond exchange offer, including CoCos, or contingent convertible notes, was £1.5bn more than expected. Just as well. Though sitting in the twilight zone between debt and equity occupied by hybrids, CoCos fulfil a more useful role: they can absorb losses, converting automatically into ordinary capital if Lloyds’ core tier one capital ratio slips below 5 per cent. Moreover, the bond exchange and Thursday’s rights issue, together raising £22.5bn, will help Lloyds to duck the government’s asset protection scheme, so saving a £15.7bn fee.

However, strong investor interest shown in Lloyds’ CoCos does not imply general acceptance. These ones were issued not for cash but in exchange for existing Lloyds bonds. Some investors felt press-ganged into accepting them because existing bonds were impaired. Because Lloyds received state assistance, Brussels ordered it to halt bond coupon payments for two years, starting in January. Still, Lloyds offered the sweetener of a coupon between 1.5 per cent and 2.5 per cent higher.

There are other problems with CoCos. They may not convert into equity fast enough if Lloyds’ apparently improving bad loan book should worsen suddenly. Furthermore, banks have failed with apparently healthy capital ratios before.

Still, bondholders have set the scene. The issue brings Lloyds closer to its capital-raising target, and appetite for CoCos indirectly indicates returning interest in its equity too. Investors marked up its shares by 3.8 per cent on Monday. The mood music is just what underwriters of its £13.5bn rights issue want to hear. Mr Daniels may yet make it out of the tunnel.

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