Retail bonds and black gold
0One of the good things about working for a traditional City of London firm is that we get invited to lots of meetings and events within a couple of minutes walking distance. Having suffered public transport to get into work, it’s rather pleasant to use the famous streets of London later in the day. As Dick Whittington found out, they aren’t exactly paved with gold, but neither are they paved with chewing gum and cigarette butts like in some other cities.
My first meeting of the week was at the London Stock Exchange, where the streets are still paved with protestors and tents, for the New Local Government Network’s launch of its study into retail bonds. The LSE has been running an order book for retail bonds (ORB) since 2010, allowing individual savers easy access to the bond markets, normally for a minimum investment of just £1,000. A growing number of private companies and public sector organisations are looking at retail bonds as an alternative way to borrow, especially as recent events have shown the importance of having a diversity of funding sources.
I see two big advantages with retail bonds. Firstly, it’s ideal for borrowing between £50 and £100 million, bringing it much more into line with larger local authorities funding needs. Wholesale capital market bonds tend to only work for issues above £150 million, too large for most of us. The smallest bond issue on ORB to date was just £20 million by RBS, while the most recent public sector issue was by the Places for People housing association for £40 million in January.
Secondly, retail investors are less sensitive to wholesale market interest rates. The rate payable on PWLB and bank loans, and on wholesale bonds, is very closely tied to the gilt market. If gilt yields rise by 0.10%, so do PWLB rates. Retail bond buyers typically target a return of around 5%, irrespective of current gilt yields. This obviously looks rather high at the moment compared with long-term PWLB rates around 4.30%, but when the economic situation improves and interest rates start to rise, 5% will start to look quite cheap. Retail investors aren’t completely insensitive to rate changes though, and if long-term rates remain low for long periods, it’s entirely plausible that a well run local authority with a good story to tell could borrow via ORB at closer to 4%.
My second meeting was at the square mile’s other august institution, the Bank of England. No tents in sight here, and all those people in jeans instead of suits turned out to be tourists for the Bank’s museum rather than protestors. On Threadneedle Street, the gold is in the vaults and in the museum displays, not on the paving stones.
The Bank’s economists were characteristically dismal about the UK economy, but I expected nothing less – they can hardly paint a rosy picture of the future while maintaining rock bottom interest rates and pumping more emergency funds into the money supply. The newest concern is whether the political situation in Iran, alongside events in Syria, will cause further rises in the oil price. This “black gold” is so ingrained into our economy, from the manufacture of plastics to the transport of goods and the supply of energy in our homes, that the Middle East is a key driver of UK growth and inflation. The only saving grace is that a continued high oil price will make it cheaper to produce goods at home than to ship them over from China.
Ralph McTell once sang that he’d take us by the hand, lead us through the streets of London and show us something to make us change our minds. My walks across the City this week have only reinforced my view that we are still waiting for the big game changing event to drag us out of the economic doldrums.
David Green is the Head of Sterling Consultancy Services, a provider of treasury management advice to local authorities and other not for profit organisations. This is the writer’s personal opinion and does not constitute investment advice. It should not be relied upon when making investment decisions.
