Lloyds lifts lid on liquidity manoeuvre

LONDON, July 12 (IFR) - Lloyds TSB said this week's GBP4.6bn senior debt buyback will reduce its interest costs substantially and trim the negative carry on its cash pile that it had prudently shored up in anticipation of a punitive downgrade by Moody's.

The liability management exercise was hailed as a shrewd move by market observers, who noted that Lloyds is one of the few Single A rated banks that can afford such a manoeuvre.

Lloyds bought back around a third of the GBP13.7bn-worth of senior bonds it had initially targeted in the buyback across US dollars, euros and sterling - a relatively good participation rate which was partly driven by a generous premium offered, banking sources said.

"Our strong capital and funding position means we are unconstrained in our lending to SMEs therefore this was a prudent exercise to manage the Group's wholesale markets debt levels by utilising the Group's strong liquidity position," said Richard Shrimpton, group capital markets issuance director at Lloyds.

Market observers reckoned the issuer offered as much as a 50bp premium for the euro and dollar purchases, while the sterling buybacks yielded almost no premium. IFR analysts estimated that the bank has saved around GBP230m in annual interest payments by completing the exercise.

The tender also stood out at a time when most other banks, especially those that fared worse when Moody's rating axe fell on the sector last month, are focused on boosting liquidity.

"This was a very interesting move from Lloyds," said a liability management banker.

"While the majority of European banks have been focused on buying back capital and creating core equity, Lloyds is showing that there are other ways to improve your credit position."

Shrimpton said the exercise was intended to better manage the group's overall wholesale debt and optimise its future interest expense.

"This will hopefully drive our spreads into a level that we feel will express fair value," he said.

BENIGN RATINGS ACTION

Lloyds, which completed its 2012 funding needs in the first quarter of the year, found itself with surplus liquidly well in excess of regulatory requirements after taking a cautious approach to the anticipated Moody's review by storing up cash.

Ultimately, Lloyds suffered less than some of its counterparts in the rating agency's review after receiving just a single-notch downgrade to A2, whereas several competitors were slashed by two notches, leaving some languishing in the Triple B bucket.

According to a source, Lloyds had stored up as much as GBP24bn. That left the bank in the unusual position of having excess cash burning a hole in its pocket, which prompted the LM move.

"We have a lot of term funding coming due in the next two-and-a-half years. We could have simply let nature, if you like, take its course," said Shrimpton.

"Instead, we're accelerating some of those maturities, which should get Lloyds to a more normal volume of senior unsecured funding - in the context of shrinking reliance of wholesale funding markets."

Lloyds' liquid assets increased by GBP20bn to GBP223bn in the first quarter of 2012 - of which primary liquid assets were GBP106bn - against short-term funding of GBP91bn, according to independent research firm CreditSights.

Lloyds' Shrimpton said the bank's current requirement for liquid assets stands at GBP70bn.

WIDENING SHRUGGED OFF

In the euro space, Lloyds' largest repurchase was the EUR503.2m of the EUR1.5bn 4.5% September 2014s issue at mid-swaps plus 90bp. While, in dollars USD1.25bn buyback of the USD2.5bn 6.375% January 2021s achieved the most significant take-up from investors.

The market initially responded positively to the liquidity manoeuvre, prompting a 50bp-70bp tightening in the dollar bonds and a smaller, but still significant, 40bp rally in both the euro and sterling bonds.

However, although the dollar-denominated 2021 bonds held steady after the operation, the euro-denominated September 2014 issues widened by 20bp above the buyback offer.

One banker not involved in the transaction said the widening merely reflected a correction following the 50bp tightening in the bonds after the tender was announced at the end of June and did not reflect negatively on the exercise itself.

The take-up across the piece was 34% (GBP4.6bn-equivalent), said a spokesman at one of the dealer managers - Deutsche Bank and Lloyds - highlighting the fact that the result for the any-and-all US part of the exercise was a very high 42%, even without the involvement of a US bank.

While there were no preconceived ideas as to what sort of participation to expect, he said that anything over 20% should be viewed as a success, especially given that this was a senior buyback rather than the more-often-seen exercises that target capital instruments.

As to whether more such senior buybacks will be forthcoming, he said there were a limited number of banks in the same position of being well-funded and with high liquidity. Ratings play a role, he said, as lower ratings lead to liquidity draining away, thus making the situation more difficult.

If/when there is a recovery, however, he sees more scope for repetition and discussions are under way with a number of institutions. "Lloyds is often a market-leader in these things," he added.