Retail bond lenders struggle to find borrowers
Retail bonds, which allow private investors to lend directly to a company in smaller amounts than is usual with a corporate bond, have proved incredibly popular.
Since its launch in February 2010, the London Stock Exchange's Order Book for Retail Bonds (ORB), which lists retail bonds available for primary subscription and secondary trading in the UK, has raised more than £4 billion for issuers.
Over the past year issuances have slowed: only six companies launched retail bonds in the 12 months to June, compared to 16 new issues between June 2012 and 2013.
However, as launches continue to be oversubscribed it seems there is still strong investor appetite for these instruments, which remain attractive in a persistently low interest rate environment.
Retail bonds are fixed-interest instruments that allow companies to borrow relatively modest amounts of capital, usually between £50 million and £150 million, from private investors in return for a yield typically between 5 and 7 per cent. Maturities range from five to 10 years, though seven years is typical.
According to Adrian Bell, head of UK debt markets at retail bond distributor Canaccord Genuity, the most attractive features of retail bonds is their accessibility and comprehensibility compared to traditional corporate bonds.
'Retail bonds can be bought in increments of £1,000 or even £100, whereas wholesale corporate bonds tend to have minimum subscriptions of £100,000, which is obviously a deterrent to private investors.
Secondly, wholesale bonds tend to be sold on a spread to government securities, whereas retail bonds tend to be sold very simply at a par price of £1 in the £1, so it's very easy to work out exactly what you're getting,' he says.
The creation in 2010 of ORB, which currently lists 180 retail-size bonds, has also provided a clear and transparent platform for these instruments, which investors can reference to buy and trade new and existing issues through their stockbroker.
|Date listed||Issuer||Yield (%)||Maturity (years)||Issue size (£m)||Price (p)|
|Source: LSE Order Book for Retail Bonds, as at 27 June 2014.|
This ability to trade on a secondary market sets retail bonds apart from mini-bonds, which have also proved popular recently. Mini-bonds have been successfully issued by retailers including Hotel Chocolat, renewable energy supplier Good Energy, horse racing group The Jockey Club and, more recently, Mexican food retailer Chilango.
Like retail bonds, mini-bonds can usually be purchased in units of £100 to £1,000 and pay a coupon of between 5 and 7 per cent, although some pay more.
Most issuers also offer extra 'perks' to investors, such as Chilango's free burrito vouchers or The Jockey Club's racing reward points, while Hotel Chocolat pays its entire coupon in chocolate.
As mini-bonds cannot be traded they must be held to maturity, which is usually around five years. Mini-bonds are usually unsecured, which means that in the event of a default, mini-bond lenders will rank behind any secured creditors - the number of which may increase unabated throughout the mini-bond's life, further subjugating the rights of mini-bondholders.
Mini-bonds are also not subject to the same regulatory scrutiny as retails bonds, the documentation for which is pored over by lawyers and accountants, then vetted by ORB and the distributing stockbroker before being offered to private investors. Mini-bond issuers often produce nothing more substantial than a 10-page brochure.
Another difference is that retail bonds can be held in Isas and self-invested personal pensions (Sipps), so investors have the opportunity to bank the full yield they receive on their bonds tax-free.
In contrast, mini-bondholders do not qualify and are therefore subject to 20 per cent basic-rate tax deductions, meaning, for example, that a 6 per cent yield is reduced to 4.8 per cent.
ORB has witnessed a number of successful retail bond issues since its launch in 2010. During that time 42 ORB dedicated retail bonds have been issued by 26 issuers including National Grid, Tesco, Severn Trent, the London Stock Exchange and most recently, Ladbrokes.
According to Bell, each issue on ORB has met with strong investor demand, with many issuers raising far more than they had initially targeted within days of launching their offering.
'Ladbrokes wanted to borrow £100 million but in four days had raised £130 million and had to cut allocations back. Paragon was also looking for £100 million and got £140 million of demand in five days; it eventually issued £125 million,' he says.
What is more, almost every retail bond issued on ORB is currently trading above par, or the issue price, meaning investors have also benefited from capital appreciation. These include the index-linked retail bond issued by National Grid in September 2011, which is now trading at 109p, 9p per above its issue price, despite currently yielding only 1.25 per cent.
According to Bell, retail bonds appeal to a broad investor base, from seasoned investors 'simply replacing bonds they may have held in a different format' to 'refugees from bank deposits' who are attracted by the high yields and lower risk relative to equities.
Bell claims that demand for these instruments remains robust across the board. 'People are very happy to buy names they are less acquainted with if the pricing is attractive,' he says.
Despite this, however, fewer and fewer issuers are coming to the retail bond market. In the year to date only two issuers have launched offerings: Paragon Group in January and Ladbrokes in June. This compares to five launches from January to June 2013 and 15 launches in 2012.
Ian Dixon, head of debt capital markets at Investec Bank, claims this is largely due to a shift in lending attitude among UK banks. 'The retail bond market has been a little bit quieter than anybody would have liked recently.
'The main issue is that the banks are more liquid now and are offering better rates to companies, which are more competitive than the retail market at this time,' he explains. Bell agrees, adding that stiffer competition within the market may also be playing a role.
retail bond pick-up
However, both experts claim we may see a 'pick-up' in retail bond issuance as pricing becomes more competitive. 'As volume has reduced the prices have got tighter on these deals, so it becomes more attractive for other companies to issue; we may have been going through a quieter period recently, but over the next six months we will see that reverse,' says Bell.
Dixon also claims that rising interest rates are likely to make bank lending a less attractive option for companies, forcing them back into the more competitive retail market.
He says he is not concerned that rising interest rates may see a large proportion of retail bond buyers head for the exit, as bank deposit rates are unlikely to match retail bond yields in the near future, nor will a deposit account offer the opportunity for capital appreciation.
Nonetheless, Dixon does acknowledge the need for brokers such as Investec to attract new issuers into the retail bond market. 'Effectively, we've got to find deals that are more appropriate for companies so they know what the benefits are in the retail market. Bank liquidity will not continue forever so we've got to keep the retail market alive,' he says.
One such innovation is the recently launched Retail Charity Bonds (RCB), a platform developed by charitable society Allia in partnership with Canaccord. Principally, the platform will allow charities to list retail bonds on ORB cheaply through pooling resources.
According to Tim Jones, chief executive of Allia, this will help to remove one of the chief barriers to entry for smaller charities - cost - while providing a more desirable vehicle for those interested in investing in charities.
'Bondholders are particularly concerned about liquidity, price visibility and tax efficiency and those measures you get through having a listed instrument, which brought us to the idea of the RCB,' he says.
The first bond to be offered through RCB comes from Golden Lane Housing, the housing arm of the learning disability charity Mencap, which has launched a seven-year bond yielding 4.4 per cent.
Whether this marks the beginning of a 'pick-up' in retail bond issuance remains to be seen; however, if demand is strong, supply often follows.
RETAIL BONDS AT A GLANCE
- Retail bonds are fixed-income securities listed on the London Stock Exchange's Order Book for Retail Bonds (ORB).
- They are usually issued by companies who wish to borrow relatively small amounts directly from private investors.
- They tend to run for around seven years and yield between 5 and 7 per cent, and are available for minimum subscriptions of between £100 and £1,000.
- Should the bond issuer get into financial difficulty, retail bondholders will in most instances be repaid before shareholders. However, like most investments, retail bonds are not covered by the Financial Services Compensation Scheme.
- Retail bonds can be held in both Isas and Sipps, meaning investors can take advantage of tax-free yields, which is not the case with mini-bonds.
- They can be particularly useful for retirees in pension drawdown as a way to plan and draw regular income.