Lloyds Bank received overwhelming backing from investors on Monday to switch the coupon on a £1bn FRN sold in 2018 from being Libor to Sonia-based, in the first such consent solicitation for a covered bond, as financial institutions manage the transition between the two sterling reference rates.

The £1bn (€1.11bn) March 2023 floating rate note soft bullet paying a coupon of three month Libor plus 25bp was the last publicly-issued covered bond linked to Libor that the UK issuer sold – its next, a £750m three year trade in September 2018, was the first FRN from a financial institution to be linked to Sonia (Sterling Overnight Index Average).

“The primary rationale for the trade is to support the Group’s transition from IBOR to risk free rates,” Peter Green, head of public senior funding and covered bonds, Lloyds Banking Group corporate Treasury, told The CBR. “Given the sterling primary issuance market has largely transitioned from Libor to Sonia for floating rate note issuance, this trade gave us the opportunity to test the consent solicitation route to address some legacy bonds that pay a Libor coupon but mature after the end of 2021.”

Although financial institutions, particularly domestic institutions, have been working on the transition to Sonia for some time, their activity has been given renewed impetus by the Bank of England. On 27 June, for example, Andrew Hauser, executive director, markets, Bank of England, gave a speech titled “Join the revolution!” on the day the central bank published a new discussion paper on how to deal with Libor-linked collateral that matures after 2021, when Libor is expected to cease being calculated, and lacks adequate fallback provisions. Policy responses could include “some combination of rising haircuts and future eligibility restrictions”, he suggested.

Lloyds noted such regulatory impetus when announcing the consent solicitation on 11 September. As well as the coupon switch, the bank was seeking to similarly amend associated documentation and swaps.

At Monday’s bondholder meeting, 99.84% of votes received were in favour of the switch.

“We are very pleased with the result of the covered bond consent solicitation,” said Green. “Investors have generally been very positive and supportive to the trade.

“They have generally been very supportive of SONIA trades in the primary market,” he added, “so it is maybe no huge surprise that they are similarly willing to consider this change in terms from Libor to Sonia.”

The near-unanimous approval is in contrast to the varied and sometimes negative results covered bond issuers have previously encountered when seeking bondholder consent, typically for converting maturity structures from hard to soft bullet, or for rating agency switches. Lloyds itself failed to gain sufficient support to switch two HBOS covered bonds from hard to soft bullet structures in 2015, while investor turnout has at times fallen short of requirements.

A DCM banker involved in previous consent solicitations said the support for Lloyds’ move was huge, “the highest I’ve ever seen”, particularly given that investors did not receive fees for participating – a topic that had proved contentious in some previous exercises.

The banker said that the possibility that Libor-linked instruments could be treated less favourably in the Bank of England’s collateral framework had meant that in the secondary market longer-dated Libor-linked FRNs were trading at a discount to Sonia-linked paper, and that as a result of this some investors were lobbying for switches such as that executed by Lloyds.

The coupon margin adjustment will be set on 17 December ahead of the next coupon payment date on 27 December, and will be the sum of 25bp and the Libor versus Sonia interpolated basis.

Moody’s today said that the bondholder approval of Lloyds’ switch is credit positive for the issuer’s covered bonds and other Libor-linked covered bond and structured finance securities in that it paves the way for their transition to alternative benchmark rates.

“It also indicates the required spread adjustment between the benchmark rates and bondholders’ support of the issuers’ efforts to a transition away from Libor,” said the rating agency. “In particular, settling on a generally agreed procedure to derive the spread adjustment between Sonia and Libor is a key first step to help facilitate a smooth transition.”

Lloyds is seeking investor consent to similarly amend certain credit card securitisations under its Penarth programme, while Santander UK hopes to do likewise for two RMBS. The first such coupon switch consent solicitation was passed in June, for Associated British Ports.

The DCM banker said further covered bond consent solicitations like Lloyds’ could be anticipated, but that the number of FRNs launched before the transition to Sonia that mature after 2021 is limited.

The sterling market is the furthest advanced in transitioning to new risk-free rates, but also that in which covered bond FRN issuance has been highest, and exercises directly comparable to Lloyds’ in other currencies may also be limited due to the prevalence of fixed rate benchmark issuance.

However, the banker noted that coupons in maturity extension periods for soft bullet structures are typically floating linked to IBOR rates. He said whether or not issuers seek to amend such terms could depend on the fate of the relevant rates and whether rating agencies raise a concern over the use of them in extension periods, given that changing the terms would be “a big pain for something nobody thinks will happen”.