19th Jun

Co-op Bank Bailout Confirms Need for Caution

With interest rates available on the High Street remaining painfully low, savers and investors have increasingly been attracted to the relatively high rates of return and capital protection offered by retail bonds and it is now estimated that around £3.4billion is invested in these products in the UK. 

Initially, the market was dominated by big household names who wanted to raise extra capital. 

An early launch on the ORB exchange was by Tesco Personal Finance which attracted £125 million by promising to pay 5% for eight years; National Grid pulled in £260million with an offer of inflation plus 1.25% for ten years, and water company Severn Trent raised £75million, promising to beat inflation by 1.3%. 

Largely based upon the recognition of, and trust in, the brand of the issuers these offers all sold out within days. 

However, interest-starved savers and investors, and particularly vulnerable pensioners who have sought to augment often meagre state pensions with income on savings, have increasingly been attracted to an investment in companies with which they may be less familiar. 

"....desperate savers may be lending up to £4m a day to companies they know very little about"

In total a hundred and eighty companies are now listed on the retail bond market, and the recent early closure of the 6% offer from property developer Helical Bar suggests that desperate savers may be lending up to £4million a day to companies they know very little about. 

Caveat Emptor

In a recent article (Caveat Emptor – Mr Bond Urges Caution When Purchasing ‘Retail Bonds’ – 7th June 2013) Retail Bond Expert (RBE) called for investors to be given access to full and transparent information that allows them to make informed investment decisions and understand the risks to which they are potentially exposed.

RBE also called for standardisation in the way that the various product types collectively known as retail bonds are presented, including loyalty bonds which have sought to lure investors with a range of incentives as diverse as chocolate and shopping vouchers. 

The sentiment behind RBE’s call for caution was entirely endorsed by this week’s £1.5billion bailout for Co-op Bank which laid bare the danger for those who abandon High Street savings for bonds. 

As part of a rescue bid to shore up the mutual, 7,000 members who invested £1,000 or more in the bank’s Permanent Interest Bearing Shares (PIBS), which have many similar characteristics to retail bonds, face a drastic cut in income and a likely loss of capital as the group plans to convert them into shares. 

In short, Co-op Bank plans to use the money invested by bond-holders, often pensioners, in what was promoted as an ethically sound and financially secure proposition, to shore up its finances; there are fears that a similar fate could befall retail-bond investors, particularly if they unwittingly back a firm that hits parlous financial straits. 

Know The Facts Prior To Purchase

As before RBE urges potential investors and their advisers to ensure that they are in possession of all the facts before lending to a company and that they are comfortable with its business plan and prospects.  

However successful it may have been in freeing up cash for SMEs, the Government’s £80billion Funding For Lending scheme has meant that the banks now have a cheap source of funding and no longer need to work as hard to get funds from savers. Already historically low, interest payments have come under further pressure and many savers have had to eat into their reserves; consequently alternative sources of income such as retail bond dividends have become even more attractive. 

Mr Bond says... "Potential investors should consider the duration of the bond – those issued for less than five years cannot be wrapped into an ISA and therefore attract income tax at the individual’s highest marginal rate – and only those listed on ORB will be traded in the secondary market."

Potential investors should consider the duration of the bond – those issued for less than five years cannot be wrapped into an ISA and therefore attract income tax at the individual’s highest marginal rate – and only those listed on ORB will be traded in the secondary market.     

However, a listing is no guarantee of liquidity and the value of bonds in poorly performing companies may decline in line with shares in the business; those needing to liquidate assets before the maturity of the bond may find that the value of their capital investment has fallen. 

In the extreme circumstance that the issuing company should fail, despite the fact that historical data suggests that levels of capital returned to the investor are actually quite high, there is no recourse to the Financial Services Compensation Scheme, so the lure of an attractive coupon should always be viewed in light of the attendant risk.    

Eden Riche, Head of Debt Capital Markets at Investec  confirmed RBE’s stance: ‘The fact is that there’s no free lunch. This really is a case of caveat emptor — let the buyer beware.’ 

However unlikely it is considered in the short term, a further risk worthy of consideration would be that created by an interest rate hike by the Bank Of England. In this instance companies issuing new bonds would then have to pay higher interest rates to remain attractive; if investors began to offload older bonds to seek greater returns, prices would be likely to fall for those selling early. 

Clearly, the purchase of a retail bond should only be considered once all factors have been considered, and the sector has been clouded by some of the non-financial incentives offered by those issuing ‘loyalty bonds’. 

Patrick Connolly, of financial adviser Chase de Vere, remarks: ‘There are all sorts of companies bringing their bonds to market — and it’s vital you don’t go into this blindfolded. ‘Let’s be clear, not one of these companies has gone under or even looks like doing so. But the risk is crystal-clear: anyone buying a bond is exposing themselves to the fortunes of just one company.’ 

Ben Yearsley, head of research at broker Charles Stanley, says: ‘As more people pile into these types of investments, seeking an alternative to the small amounts of savings income on offer on the High Street, it’s absolutely critical to know what you’re buying. ‘Although retail bonds can be a good investment, make sure you understand the company’s business plan, its products and what it really does.’ 

In light of the Co-op Bank conversion, it appears that would-be investors not only have to weigh the risk-reward potential of a particular retail bond issue, but need to be aware of the range of consequences of taking a position should things go against the business they propose to lend to.   

See how one amateur investor approaches things here: where to invest money

RBE seeks to bring crowd-sourced opinion to the retail bond sector and welcomes the perspective of investors, advisers, industry professionals and commentators.   

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