Save with bonds, not banks

The newswires are red-hot with talk about the next governor of the Bank of England, Mark Carney. But the King hasn’t handed over the crown just yet.

Yesterday, the incumbent governor had a message for the banks: start mustering up some cash! He said that as the eurozone crisis drags on, the banks would need about £60bn. And that’s just to keep our big four’s balance sheets intact.

King wants them to raise capital from the markets. But as I pointed out just a couple of weeks ago, the banks are quite happy to rebuild their balance sheets at the expense of customers. Remember the charts I used in that article that showed how savers are being made to pay for the banks’ mistakes.

As a result savers are turning away from the banks in droves. And one of the beneficiaries has been the corporate bond market.

If you’re looking for somewhere to stash some cash for a reasonable – and reasonably safe – return, then today I might have just the thing…

The bond market has overheated

I’ve pointed out several times that low interest rates seem to be here to stay. Mark Carney isn’t likely to bring any fresh ideas on that score. After all, the banks have got many years of capital rebuilding to do.

And as savers avoid the banks by lending cash directly to corporate borrowers (corporate bonds), the market has gotten a little over-heated. It was a point I made  a couple of weeks ago when I said the bond offering from haulier Eddie Stobart was bad value. They were offering savers 5.5% a year fixed for six years. But as I said, there was absolutely no security offered against these bonds. It looked like a complete rip-off to me.

And it was an excellent sign for the corporate bond market that the offering was shelved just days later. It seems that even in the red hot corporate bond market, fools can’t be parted from their money that easily!

A few days ago another, much better bond offering was announced. It won’t be for everyone, but in my opinion, it’s sure as heck a much better deal than recent offerings from the sector.

A tempting 5.75% fixed bond

The thing that I’ve always liked about corporate bonds is that they offer decent security. It’s a bit like a mortgage – if the lender doesn’t get paid back (be it interest, or the final capital at maturity), then he can take charge of some asset. For obvious reasons, buildings are popular collateral.

But bonds are in such demand lately that issuers haven’t bothered offering any security at all.

So it’s a pleasure to see this week’s announcement from Alpha Plus that it wants to raise £50m- £55m by way of a securitised bond. It promises 5.75% fixed for seven years. The security is a property portfolio valued at £84m.

So who are Alpha Plus? Good question - I hadn’t heard of them either!

Alpha Plus is a private education group that owns 19 schools and nurseries – including Wetherby, the pre-prep for boys that educated princes William and Harry, and Hugh Grant. It’s chaired by property veteran Sir John Ritblat, who built British Land into the giant it is today.

It looks like Alpha Plus wants to use the bond to repay initial investors and provide a few quid for growing the business.

And it looks like a good business. Its portfolio of elite London schools has never been more popular. There’s a lot of money floating around the higher echelons of London society!

The bond is to be secured against seven of its schools that together are worth about one and a half times the value of the bond. What’s more, management say that they will maintain this valuation multiple. That is, if the security value becomes impaired, then they’ll pony up more property from its portfolio to maintain the security value at 1.5 times the value of the bond issue.

New issues are never going to be a steal

As I said at the outset, this bond won’t be for everyone. But the good thing with this type of fixed interest saving as opposed to some of the rubbish offered by high street banks is that if you need the cash, you can always sell the bond on the market.

Now you may not get back what you paid for it… you may get more, you may get less depending on market demand. But at least there won’t be any interest penalty for doing so. And it’s important to bear in mind that corporate bonds are not covered by the financial services compensation scheme (FSCS) – and that’s one very good reason why savers should want some decent physical assets backing your bond!

Interest is paid twice yearly and you can pop them in an ISA, or SIPP to keep the tax man at bay.

I am neither recommending these bonds, nor urging caution. All I want to say is that I much prefer them to most of the stuff entering the retail bond arena these days.

If you want to avoid the banks and get what in today’s world looks like a reasonable return, backed by some valuable prime London assets, then this could be an OK place to stash some cash.

Minimum subscription is for £2,000 – and if you want in, ask your stockbroker if they’re taking part in the offering. You can get a pretty good summary of the offering here.

It’s a shame I can’t be more enthusiastic, I know. But this wretched low interest rate environment makes sure that new issues coming to market are never going to be a steal. An OK offer is as good as it gets.

Still, I’ll keep looking for the best deals for you. As I’ve said before, the second-hand bond market looks like better value to me.

• This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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8 Responses

  1. 01/12/2012, Peter Hill wrote

    Enjoyed the article – I’m not at all familiar with the bond market, so with reference to your last sentence in the article, how does one access the second hand bond market?

  2. 03/12/2012, Ian wrote

    @Peter You’ll find that many online brokers can now buy and sell bonds for you – if that you normally have to do the deal over the phone rather than online. Hargreaves Lansdown for example will be able to buy most of the bonds Bendt recommends, and you can do so through a SIPP, ISA or standard share account held with them. To buy you just need the full description of the bond (as above) and ideally the code number as a double check.

    The spread is wide on many of them, but then you’re buying to hold and enjoy the income rather than trade

  3. 03/12/2012, JGH wrote

    Bengt, are you planning to analyse the Alpha Plus bond in more depth ? In principle I would be happy with the 5.75% coupon and content to hold until December 2019. However, despite the property portfolio backing it I am unsure how secure this bond really is.

    By my calculations their interest bill will rise by at least £2.18m. This may not compare well with their profit before tax of £2.64m – but that’s an accounting profit after allowing for depreciation.

    If one looks at the cashflow, their net cash position went down by £1.05m – after they spent £12. 38m on property plant and equipment. Unfortunately there’s no indication of what proportion of that figure is discretionary.

    So, how sustainable is their financial position after issuing this bond ?

  4. 03/12/2012, Tim W wrote

    Hi JGH, upfront I am not an expert in these things.

    Bengt does note that the bond is being used to pay back original creditors therefore I would assume they already have some kind of interest flow out of the company. Therefore the entire £2.18m would not come off their bottom line. It would be £2.18m – amount already paid in interest.

    Of course this needs additional inspection but I thought that might be why your sums are looking a bit negative! Hope that helps,

    Tim

  5. 03/12/2012, Tim W wrote

    Oh whoops, I may have made a mistake there. I think JGH may have already been allowing for this in their £2.18M figure. I haven’t been through the company finances myself, apologies.

  6. 03/12/2012, JGH wrote

    Tim W – thanks for your thoughts. Yes, mu calculation was made as follows.

    If the bond raises £55m as they hope, then the interest payable will be £3.16m each year. They currently have borrowings of £58.6m, on which they are paying £1.44m of interest – an average rate of almost 2.5%. The bond will be used to repay £40m of current borrowings; let’s assume that interest on the balance is paid at the same rate, ie: almost 2.5% of (£58.6m – £40m), which is £0.46m. So their interest bill will be £2.18m higher than last year (£3.16m + £0.46m – £1.44m).

  7. 05/12/2012, Bengt wrote

    JGH

    Unfortuantely, I don’t have the time to do due diligence on this bond – and I wouldn’t want to make too much comment without doing so.

    But I will say one thing. The guys involved (and sometimes we must look at the pedigree of management and investors) are guys that can raise finance if needs must.

    The very fact that they’ve assured the bond with such security speaks volumes to me.

    At first sight, this looks miles better than most bonds paying an equivalent interest payment.

  8. 07/12/2012, JGH wrote

    Thanks, Bengt. In fact I spent more time poring over the numbers and placed my order on Tuesday.

Commenting on this article closed

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