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Bond of the Week: 14 March 2012

US banks show sharp improvement. What of bank debt in the UK?


The big news this week is the clean bill of health awarded by the US Federal Reserve to 15 banks. The US central bank has declared that the majority of these institutions (but sadly not Citigroup) have ample reserves and are free to pay dividends. Good news indeed for the financial markets, which have reacted with a typical "risk on" swing; equities up, government bonds down.

What of bank debt? This sector has been somewhat unloved for some time. Traditionally, the biggest buyers of bank debt have been the banks themselves. With the industry shrinking its balance sheets, this mutually-beneficial habit has somewhat diminished. Add in investor’s re-evaluation of the risk in the sector and it is no surprise that bank debt is still trading at considerably wider margins than the historic average, even allowing for the improvement seen over the last few months.

Is there value still to be had? I would say just about, but in senior bonds, it’s getting more marginal.

Take the point of the Lloyds 5.5% Sept 2016 senior bond issue. This bond was launched at par this time last year. At the time, the 5.5% YTM offered an incremental yield of 2.7% more than gilts of an equivalent maturity. The details are as follows:

  • Issuer - Lloyds TSB Bank (senior)
  • Coupon - 5.5% s/a
  • Maturity 25 Sept 2016
  • Price - 104.75
  • YTM - 4.3%
  • Credit rating - A (S&P)
  • Size of issue - £150 million
  • Min piece - £1,000
  • ISIN - XS0604804194

Since then, the gilt market has rallied and this has dragged the Lloyds 5.5% 2016 along in its wake. The price has risen to 104.75 (offer side) and the yield has dropped according to 4.3%. I considered the bond to be very good value a year ago. How about now?

My view: At 4.3% YTM, the Lloyds 5.5% Sept 2016 continues to represent fair value and investors who bought the bond at launch in an ISA account should hang on. All things being equal, the bond should hold its over-par value for the next couple of years as the instrument picks up a tail wind from the steep yield curve. Consider also that on relative-to-gilt terms, the bond is still cheap, offering 3.4% more than gilts of the same maturity.

Sadly, for new investors, this four-and-half year bond is now too short to be included as a new entry in an ISA, but can be considered as a deposit-beating alternative in a SIPPS.

Mark Glowrey


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