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Bond of the Week: Royal Sun Alliance gets jiggy with the balance sheet
Bond of the Week, 29th November: Royal Sun Alliance Perpetual
Royal Sun Alliance has been busy re-jigging its balance sheet. Back in May of this year, the company completed a transaction to replace an outstanding USD denominated bond, offering holders a new "tier-1", or subordinated*, sterling denominated bond, issued at a yield premium or "spread" of 1.87% over the return on the 10-year Gilt. The issue met with good demand and the majority of bond holders accepted the offer, with RSA taking the opportunity to add a further £78 million to the deal to create an issue of £375 million, equivalent to around 13% of RSAís market capitilisation at the time
The bond pays a 6.701% fixed coupon and is a perpetual, or undated issue. From the point of view of an investor, and undated bond might seem a rather unappealing proposition; effectively a loan that never gets repaid! However this type of instrument does have the advantage of providing a steady stream of income for a lengthy period of time. The investor can "redeem" his investment by selling his holding in the market, and in this respect perpetual bonds resemble equities where the final realization of the asset is subject to market forces. It is also worthy of note to consider that the longer an investor holds a bond for, the less important the final "bullet" payment is, compared to the considerable cash flows that will be obtained from the coupons and reinvestment thereof.
The bondís coupon changes from the current fixed 6.701% to a floating 3-month LIBOR + 251bp in July 2017. This coincides with the issuerís option to "call" or redeem the bond at par. Based on the present market environment, and the hefty "step-up" nature of this floating rate coupon, it is reasonable to assume that the bonds would be redeemed by the issuer at that point in time.
International Credit rating agency Standard & Poorís gives the bond a BBB credit rating, putting this particular instrument down at the lower end of our criteria for the model portfolio. Currently trading at 101.97 to give a running yield of 6.58%, this is one of the higher yielding investment grade opportunities available in the sterling fixed income market at present. The instrument is not without risk, both from the point of view of the subordinated status of the debt, which adds default risk and the undated maturity, which adds duration, or interest rate risk. We view this bond as an interesting opportunity for risk-positive investors. At present, we will not be adding this instrument to our model portfolio, but we would be tempted to add a holding, particularly on a pullback below par, such as the sharp dip seen in June of this year.
Please note, this bond has a minimum holding requirement of GBP50,000, so may be unsuitable for smaller size portfolios.
* See Glossary for definition of subordinated