28th October 2013
The Co-operative bank deal may be bad news for those whose super-ethical bank is now owned by a US hedge fund, but it has generally been good for bondholders. It has demonstrated that, in the event of a default most are not left empty-handed. The trouble is, investors had to know which type of debt to buy and the position of the group’s retail bondholders is still uncertain. Should the debacle sound a warning for holders of retail bonds generally?
Investment journalist Cherry Reynard analyses the issue.
Co-op group, the parent of the troubled bank, has now agreed to a restructuring, which will leave it with a 30% stake in the bank. It previously owned the bank outright. The bank ran into difficulties having taken over Britannia with its book of toxic property loans and has been struggling to fill a £1.5bn hole in its funding.
The deal is thought to be positive for retail bondholders. This article from Reuters says: “Sources with knowledge of the matter said the new proposals would protect the Co-op Bank’s 15,000 retail bondholders, many of whom are pensioners who had relied on coupons from their investments. They are likely to receive a new income bearing bond rather than having their debt converted into shares.
Mark Taber, who has campaigned on behalf of retail investors, welcomed that development, but said he needed to see more details of the new plan. “If they are being offered a bond, the terms will be important. They will need to consider how it’s going to be structured and approached and the mechanics of it and make sure people aren’t treated unfairly within it or left out.”
The other option mooted has been a hardship fund. The Financial Times reported: “This “hardship fund” would be aimed at easing losses for those individual investors hit hardest by the Co-op Bank’s plan to swap £1bn of existing debt for equity and new bonds, according to people familiar with the plan.”
Retail investors have campaigned hard against the restructuring, but the Co-operative cannot legally prioritise their interests over other bondholders such as fund managers or hedge funds because their bonds rank below those of other bondholders. It may seem unfair that it is the proverbial ‘little’ guy that is facing the most significant haircuts to the value of his bonds, but regulators might have to intervene if retail investors were allowed to take precedence over higher ranked creditors.
This has long been the argument against retail investors holding bonds direct. Stephen Snowden, manager of the Kames Investment Grade Bond fund has previously pointed out that in some cases retail investors receive a lower yield than institutional buyers, while taking on materially more default risk. He was talking about National Grid bonds, where the retail bond was issued out of the parent holding company, in contrast to the institutional bonds, which were issued out of the UK regulated operating company, but the same could apply to the Co-op bonds.
At launch the bonds were paying just 5.55%. They were launched after the Britannia merger, so the problems should have already started to emerge. Here is the price chart on the London stock exchange before the bond’s suspension.
Later, in the secondary market the yield on a number of the group’s bonds moved to 17% and higher. This is likely to have been the point at which institutional investors swooped in. They were getting well-compensated for the risks they were taking; the bond-holders who were still getting below 6% were not. The Telegraph points out that even the top-ranked bonds – i.e. those bonds that have first call on any available money in the event of problems at the bank – were yielding 7%.
Retail bondholders may yet get paid, but the investment has not proved to be the steady reliable source of income that many would have expected. It is a living, breathing example of the problems with retail bonds. In some cases, these are a welcome democratisation of a market previously dominated by institutions, but some of these bonds do not have the risk profile that investors expect. Investors have to ensure that they understand where they appear in the pecking order in the event of corporate problems and that they are paid appropriately for the risks they are taking.