Wednesday 13 July 2011

Guaranteed 9% Yield!

Don't you hate those ads! They couldn't possibly be true, could they?

Well, I might be exaggerating ever-so-slightly here, but - yes dear reader, it is shockingly true. Here are not just one but several securities that have a yield-to-maturity of around 9% in an institution that is effectively owned by the British tax-payer. How safe can you get, and how could you find a bigger return? Is this buried treasure or Fool's Gold?

I've underlined in a recent post that a high fixed yield today is usually worth more over the medium term than a lower, but growing yield - provided that the risk of losing your money is vanishingly low. The big problem with high-yield dividend shares is that dividend is not guaranteed - you have to accept the risk that dividends may not grow or may even be reduced. And that happens more often than we would like.

But the problem with high-yielding fixed yields, such as corporate bonds is that a high yield usually indicates a higher risk of default.

But buried in the wreckage that is Lloyds Banking Group - rescued by the UK Government - is an unusual class of securities Enhanced Capital Notes - there are about 20 different types, each with different maturities, coupons and yields.

To quote Collins Stewart:
  •  Enhanced Capital Notes (ECNs) are a form of contingent convertible issued by Lloyds Banking Group PLC. Holders of a number of existing Lloyds securities were offered the opportunity to convert their holdings into ECNs on a 1 for 1 basis. This followed a European Commission ruling that optional coupon payments should cease on existing securities whilst Lloyds was in receipt of state support. These dividend restrictions will last at least until February 2012."

In other words, this was a dodge to keep paying the coupon on the preference shares held mainly by the big financial institutions. And because they are no longer 'prefs', they are paid gross, without the UK's 10% dividend 'tax' (yes, I know, it's not really a tax...).

The unusual feature of ECNs is that (again quoting Collins Stewart):
  •  If the Group s published consolidated core tier 1 ratio falls to less than 5 per cent, the ECNs automatically convert into Lloyds ordinary shares at a rate of 1.68892 ordinary shares per £1 of ECNs. This acts to increase Lloyds core tier 1 capital ratio at the time of conversion."

So, there is a (small) chance that you might end up with fairly worthless shares in Lloyds. Unlike most convertible bonds, this will only happen in case of a failure - meaning that they are rated as junk bonds by Fitch.

And the "9% yield" I was claiming? Collins Stewart publish yields showing (in early July 2011) yields-to-maturity of up to 9.96% for LBG 16.125% (10/12/2024) LB20 (admittedly you would have to buy £50k's worth to get that). Or for the investor of more modest means you might go for LBG 11.125% (4/11/2020) which is dealt in bundles of £1k with a YTM of 8.99%.

Now, none of this is actually 'guaranteed' - but with such a huge stake in the company, is it likely that the UK Government would allow Lloyds to fail now? I think not.

I don't know how easy these are to buy yet. ECNs are dealt 'clean' of accrued interest: this means that the accrued interest is settled separately, as is the case with bonds. Be aware that the securities are dealt only in round amounts, varying from 1,000 up to 100,000 shares, although LBG 7.975% does trade in individual shares (with a YTM of 8.6%).

So have I convinced you? A guaranteed 9% yield? Or not?

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. HILARY - NO!

    It is one of my investing rules never, ever to touch any BANK instrument. Too many unknowns and so many lesser risk alternatives.

    I'll post later where to find secure high yields with capital gain potential.


  2. Hilary:-

    I agree with you 100% on the importance of dividends. A yield features large in my asset allocation criteria, either directly through a choice of fixed or quasi fixed interest stocks; or indirectly through equity selection.

    By quasi fixed interest I refer to the lamentably disappearing Zero Dividend Preference Shares (“ZDPs”). Those superb instruments provide Gross Redemption Yields for a capital gain over a defined period. The hay-day for many Zero followers were the halcyon years of 2002/5 which followed the Split Level Investment Trust scandal of 2001. Sadly many ignorant investors and brokers binned their ZDPs, just when they should have been buying. I was one of the lucky few who, having just taken early retirement, had the time to research the true situation. Totally secure GRYs of 15%+ were commonplace. How I miss those days.

    Now and again another ZDP arrives on the scene. F&C Private Equity Trust ZDP (FPEZ) was one such; though I am now out as the price has risen to a level where the yield is no longer attractive:

    In recent times I have held various different preference shares yielding 7.8% - 12.5%:


    It has to be said that undated preference shares can be a long-term hostage to fortune should inflation really set in and interest rates rise alarmingly. So I never Buy to Hold. In fact, I am out of all of those at the moment with the single exception of RECP, which gives a secure 8%pa to maturity in 6 years time.

    So, where to find high yields from equities?

    Personally I love the commercial property sector, a sector not widely followed or understood by the average PI who tends to think of property as houses! For me the opportunities that frequently present themselves of effectively buying first class property portfolios at substantial discounts to the underlying NAV, provide both a measure of security and also, quite often, tempting yields too.

    To play the sector one has to follow the trend of the major blue chips such as BLND, GPOR, HMSO, LAND….or quite simply follow the REITs Index.

    Most of the blue chip companies now stand at or above NAV, not what I see as value, but the institutions keep buying as the underlying fundamentals of prime commercial property are sound; and the yields from commercial property are attractive in the continuing low interest rate environment.

    My advice is to dip below the blue chips into the often quite incredible value to be found from the secondary players. I’ll mention just two:

    # Invista Foundation Property Trust – “IFD”

    Key Stats:

    # Sp = 38p
    # EPRA NAV = 57.4p
    # NAV Discount = 34%
    # Dividend = 4 x 0.88p = 3.52p
    # Yield = 9.3%
    # LTV = 37% Net of Cash (Low net borrowings for a property co.)

    NB: The dividend is uncovered, but all the Company’s statements, actions and presentations suggest the current dividend level is safe - the aim is to cover the dividend by 2013. See posts 168 onwards on this thread:

    Also see the anticipated rental chart on page 27 of the December presentation to analysts:

    This is one of the great value stocks on the Market at the moment; and the shortly upcoming IMS/NAV/Divi statement should confirm this fact.

    I said I would mention two. The second is in the next Post.

  3. The second is McKay Securities – “MCKS”:

    Key Stats:

    # Sp = 133p
    # EPRA NAV = 223p
    # NAV Discount = 40.4%
    # Dividend = 8.3p
    # Yield = 6.24%
    # LTV = 43%

    Here the yield isn’t quite so enticing, but a detailed look at the recent Prelims suggests clear opportunities for an increased dividend in the current year – note, MCKS is a REIT so has no option but to pay out minimally 90% of its property rental profits.

    When combined with the exceptionally attractive NAV discount, MCKS also provides quite outstanding value.

    Take a look at Post No.484 on this link to see how the rising tide in commercial property companies has left MCKS stranded for too long. Time to play catch-up…

  4. Lloyds actions were very questionable and this could be a ploy. The rates are high as the industry dont trust them, I have just gone a very bad time with Bank of Ireland PIBS. The Finance Minister and Bank have created legislation where they can reduce the value of a bond to a cent. They conned the Italians into agreeing to this. The UK holders kicked up a big stink and the had to abandon the scheme and pay out the interest

    The property funds are good I also have a list of IT companies that pay good dividens,with no stamp duty or tax on the dividends great for an ISA or SIPP.

    Invista is on the list

  5. Scuse my thickery, but why do you state that 10% on dividends is "not really a 'tax'"? Semantics?

    Not being provocative - and I'm sorry if it's a hoary old point. I'd really like to know.


    1. Not thickery, sir. The (in)famous Mr G Brown decided to levy s tax on pension funds, who had been benefitting from a tax-free income from dividends. So he decided to implement a withholding tax of 10% on all UK company dividends. This withholding tax is offsettable by the ordinary punter as a payment on account of his mainstream liability on the dividends received. However, pension funds - and ISAS - cannot reclaim the tax suffered, even if they are "tax free" investment vehicles.

  6. Skyship

    You are scared of bank prefs. I find them attractive. The difference in viewpoints is due to how you see the following factors:

    Inflation: as you say, high interest rates would make them less attractive.

    *But* I see inflation as staying low for many years (it is one way the UK is deleveraging without cutting those "sticky wages" mentioned by Keynes).

    Banking sector: vulnerable to events such as a Greek Default / Eurozone crisis.

    *But*, there are two responses to that. The first is a general "These instruments just depend on the banks staying upright. If the banks were going to go bust they would have gone bust already. Now the govt owns half the sector, it's even less likely they will go bust". The second is the general Vickers/Basel changes so that by 2019 the Tier1 capital buffers of the banks will be much much greater.

    In the meantime there is fear, which brings opportunity.