……the Bond that came in from the cold
It is now the 8th anniversary of the Base Rate cut to 0.50% in March 2009 and there has been no respite for savers – the only change was to reduce it still further, to 0.25% in August 2016.
The table below shows that the pain may not be going away quickly either…….
|Forecast||Actual||Q1 2017||Q2 2017||Q3 2017||Q4 2017||2020|
|UK Base Rate||0.25%||0.25%||0.25%||0.25%||0.5%||1.25%|
Because of this hunt for yield goes on, especially as inflation is now approaching government targets, and showing no sign of slowing down.
This has left Mr Bond in a quandary, torn between good and evil.
The ‘good’ being the LSE listed bonds he championed in an article published here on the 22nd September 2016; ‘Buy British and list on the LSE’ – it’s all about the listing says Mr Bond’; and the ‘bad’ being unlisted ‘mini-bonds’
On the 9th September 2016 DIY Investor wrote about the Mini-bond failure of the Providence Financial issue –‘Investors sweat as mini bond issuer goes bust’.
This isn’t the only mini-bond to fail, there have been others – e.g. the Secured Energy Bonds, Jan 2016.
It is to the22nd September article that Mr Bond is returning; there were two statements, the first ‘…, if it isn’t listed it likely best avoided; period’, and the second, ‘‘the ‘gold standard’ in Europe for bond investors is the prospectus directive’. For the sake of clarity all bonds listed on the LSE fall under the Prospectus Directive (“PD”).
‘like cold-war spies seeking to lure him with their tantalising coupons’
Whilst Mr Bond is happy to defend championing LSE listed issues, he acknowledges the lack of supply, with only five new issues since the beginning of 2016, whereas the bad old mini-bond market is churning them out like cold-war spies seeking to lure him with their tantalising coupons.
All this set Mr Bond thinking; is there a third-way? One where he can have the seductive wiles of the mini-bond but with some of the benefits of the PD?
Before reading on there is some caveat emptor, whatever you do the mini-bond will be unlisted, meaning that there is no on-going no liquidity and the investment must be held to maturity.
We spoke to a firm that arranges listed bonds and discussed other comparisons, liquidity aside, between listed and mini-bonds. The issuers of mini-bonds tend to be ‘smaller’ businesses borrowing smaller amounts of money; because of this, coupons should be higher, we would expect 7% possibly 8%.
‘there is no on-going no liquidity and the investment must be held to maturity’
One of the biggest problems is that the issuers tend be new businesses with little or no accounting history. Whereas, under the PD the issuer, or guarantor, is required to have two years audited accounts of ‘substance’. Some mini-bond issuers have tried to overcome this by offering security, however in many instances the assets representing the security are to be purchased with the bond proceeds.
Furthermore, the assets will be income producing to service the coupons. Whilst this sounds plausible, it rarely is; for example:
- Day 1; New Co issues an 8% bond and raises £5m, in theory the security trustee hold £5m in cash as security, in practise the issue costs are deducted from the proceeds at outset. if we assume this totals £150,000 then the trustee is left holding only £4,850,000 (97% of the proceeds).
- Six months after issue the first coupon of 4% (half of 8%) is due. If the issuer hasn’t been able to invest in income generating assets then they will likely use the cash security, diminishing this by a further £200,000 to £4,650,000, or 93%.
- Meaning that in the event of a default there may not be sufficient to repay bondholders
The next point is the invitation document used by mini-bond issuers; these tend to be shorter than a PD compliant prospectus, 50 to 60 pages against 150 pages upwards. The invitation document is really a marketing booklet, with little in the way of issuer or industry specific risks disclosed, effectively a general lack of transparency and disclosure. In comparison, the PD compliant document offers a high degree of both, and financial covenants designed to protect investors by restricting how much an issuer can borrow, for example:
- An interest rate cover covenant of 1.5: 1 and a negative pledge whereby they cannot offer security to another lender (i.e. a bank) and put them ahead of bondholders, or
- Financial indebtedness of the issuer does not exceed [50%] of the sum of the Group’s total assets, or
- For so long as any Note or Coupon remains outstanding, the Issuer shall ensure that, as at each Reference date, (i) the Leverage ratio is less than 3.0: 1.0, and (ii) the ratio of EBITDA to Finance Charges of the period of 12 months ending on such reference date is not less than 4.0: 1. 0.
Mr Bond now realises that there might be a third-way, essentially a mini-bond but one where the invitation document is based around the PD providing investors with:
- the transparency and disclosure required
- with either actual security or 2-years plus accounting history
- proper financial covenants
Mr Bond understands that there is an issue being created that could address this, and stands ready to review it in future issues.
In conclusion, whilst mini-bonds will never be the true equal of an LSE listed issue, the third-way could make them ‘the bond that came in from the cold’!