1. Introduction The UK Retail Bond Market H1 2011 Performance Update Over the last 6 months, 7 transactions have been launched in the retail bond market in the UK, raising 540 million - with a further issue by the EIB, for 350 million, launched and simultaneously listed on the ORB for the first time. These have taken two distinct forms: a. Negotiable securities (7 issues), with fixed/ floating rates of interest. They are i. listed on the London Stock Exchange, ii. actively traded on the ORB in small denominations (e.g. 100), iii. promoted through an active press campaign, and iv. broadly distributed to retail investors, generally using a wide range of retail stockbrokers and wealth managers. b. Non transferable loan stock (2 issues). These were: i. primarily targeted at a limited group of investors ii. enhanced yield through annual sales vouchers or higher interest rates for customers Both types of transaction met with exceptionally strong demand from a wide range of buyers many of them first time investors in the retail bond market. However, while the public issues were launched with the primary intention of developing a new and predictable source of cost effective funding, the transactions for John Lewis and Ecotricity had a further objective to tie investors into their mainstream businesses as long term customers. Q2 2011 saw the first issue of a retail bond for a non financial corporate, opening the retail bond market as a new source of funding for the housing association sector. EVOLUTION DEBT ADVICE & ORIGINATION Adrian Bell 020 7071 4647 adrian.bell@evosecurities.com Henrietta Podd 020 7071 4621 henrietta.podd@evosecurities.com Morton Llewellyn 020 7071 4378 morton.llewellyn@evosecurities.com
2. The development of the retail bond market in the UK Primary market performance volume There has been a steady increase in the demand for Sterling bonds from retail investors in the UK over the last 12 months. This is reflected in the volume of new issue activity over the first half of 2011, as compared with the performance over the comparable period a year earlier. This is set out below: Borrower Maturity Issue Size m Coupon % Completed H1 2011 EIB 2016 350 3.25 Lloyds 2016 150 5.50 Provident Financial 2016 50 7.50 Places for People 2016 140 5.00 RBS 2018 15 3.30-8.55 RBS 2017 10 2 (FRN) Tesco Bank 2018 125 5.20 Completed H1 2010 Provident Financial 2020 25 7.00 RBS 2020 50 5.10 This performance is all the more remarkable as it has occurred: a. during a period of major market disruption, with the Japanese earthquake and the Greek debt crisis b. when investors were uncertain over the future direction of the bond markets, and c. concerned over the outlook for inflation. It contrasts with the experience of the retail bond funds, where there has been a significant slowdown in subscriptions. Demand appears to be driven by a desire from retail investors to: a. enhance the income on their savings by extending up the maturity curve, b. protect their savings from inflation, c. diversify holdings out of term deposits with the mainstream UK banks, d. reduce risk by rebalancing portfolios between equity and debt, and
e. maximise income from tax efficient saving ISAs (including junior ISAs) and SIPPs, where the attractions of investment in fixed income securities increase as the marginal rate of tax rises. In some respects the preference reflects a trend that has been apparent in Europe and North America where retail investors have traditionally played a more important role in the bond market. Since 2008 they have been very active net buyers of bonds. Primary market performance distribution The retail bond distribution network has proved to be very broad, both in terms of the number of distributors and the number of underlying clients. The table below sets out the experience of three of the recent issues shows the breadth of demand, the wide range of distributors involved and the importance of tax free savings accounts. Average Number of Distributors 45-55 Estimated Number of Underlying Clients 5,000 8,000 Average Ticket Size 15,000 Estimated % of Demand from ISAs/SIPPs 40% - 50% Source: Evolution Securities Secondary market performance With the number of issues trading on the ORB now standing at 146, including 94 corporate bonds, the market provides a wide range of investment options. Number of Issues on ORB 100 80 60 40 20 0 Gilts Corps Supras Jun-10 Jun-11 Secondary trading in retail bonds has also increased markedly year on year, providing investors with real liquidity in an active marketplace.
ORB Corporate Turnover 250,000,000 200,000,000 150,000,000 100,000,000 50,000,000 0 Jun-10 Jun-11 The retail market trades in line with the institutional market, offering competitively priced debt as well as diversification of funding. Borrower Retail Bonds Maturity Issue Size 'm Coupon % Market Price Yield Spread to Mid Swap Spread to Wholesale EIB 2016 350 3.25 103.2 2.55% 20 N/A Lloyds 2015 75 5.375 104.8 3.72% 209-30 Lloyds 2016 150 5.50 101.5 4.95% 283 44 Places for People 2016 140 5.00 101.8 4.53% 223 29 Provident Financial 2016 50 7.50 106.3 5.97% 374-152 Provident Financial 2020 25 7.00 102.8 6.28% 344-183 RBS 2020 50 5.10 96.6 5.61% 242 N/A Tesco Bank 2018 125 5.20 103.5 4.53% 180 N/A Wholesale Bonds Lloyds 2018 400 6.75 109.0 5.15% 239 Places for People 2031 175 5.875 99.3 5.89% 194 Provident Financial 2019 250 8.00 98.1 8.07% 526 Tesco 2019 350 5.50 109.3 3.96% 104
3. Market demand One of the major drivers behind the recent development of the retail bond market in the UK has been an increased focus amongst retail investors on tax efficient saving. While there is a limit on the size of annual subscriptions, SIPPs and ISAs now constitute the principal mechanism for saving for many individuals and often have accumulated values of 50,000-500,000. This is sufficient to justify holdings of between 10,000-25,000 in individual bonds, as a natural part of a balanced portfolio, focused on the development of tax efficient income. The smaller denominations available from retail issues are therefore crucial to attracting widespread demand. An indication of the potential size of the market is provided by the figures set out below: Retail Investment ( 'bn) 2010 2009 Source NS&I 99 97 NS&I Annual Report 2010 Term Deposits 272 261 Bank of England April 2011 Bond Funds 108 96 IMA 2011 Stocks & Shares ISAs & PEPs 178 116 ONS Jan 2011 Cash ISAs 172 158 ONS Jan 2011 SIPPs 90 (e) N/A Pension Management There is also, according to HSBC research, an additional 92bn of fixed rate deposit accounts which mature in 2011. As can be seen from the table above, the retail bond market in the UK has the capacity to expand rapidly in size over the next 5 years by attracting demand from existing savings instruments. This will lead to a substantial increase in the number of new investors in the market. We believe that, as a consequence, direct holdings of bonds will grow over the period to involve more than 1 million investors holding 25 50 billion of bonds. This would not only make it a major new source of finance in the Sterling market, it would involve a substantial proportion of the existing retail customer base in the UK. Investment in individual bonds offers substantial benefits for these holders over a retail bond fund, namely: i. a predictable return
ii. iii. over a predictable period of time on a known credit. With the development of the ORB by the London Stock Exchange, holders also benefit from transparency on pricing in the secondary market and, through their brokers, access to liquidity. 4. Inflation linking Retail investors offer true diversity from the wholesale market as their investment decisions are based on different drivers. A crucial element to this is that they buy on the basis of coupon and running yield rather than spread. At present, the hurdle nominal fixed rate coupon is 5%, while the hurdle for real rates is 0%. Retail investors have few means of protecting their savings from inflation without taking a view on the equity or property markets. Their demand for such products has been well illustrated by demand for NS&I products which had to be withdrawn in 2010 and have seen strong demand so far in 2011. Some banks have offered RPI linked deposit accounts which have also been well subscribed, although their illiquidity and ISA-ineligibility is unattractive to many retail investors. Index linked gilts and corporate bonds offer an attractive solution to this problem for retail investors but there are currently few that they can access and these all trade substantially over par: Bonds and Gilts on ORB 3% 6% 11% Plain vanilla Inflation linked Index linked Step up 80% Feedback from Stockbrokers and Wealth Managers suggests that inflation linked retail bonds would be met with very strong demand. Corporates can take advantage of this strong demand to obtain attractively priced inflation linked debt.
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