The rationale for my purchase of some of the Co-op’s BB+ rated
perpetual bonds was incomplete in so much as there were two attractions to the
trade. The first appeal was the price and potential return on the bond, which I
have detailed prior (and repeated below). The second appeal was the method
through which I bought them, which was through my spreadbet provider, ETX
Capital.
While it is widely known that indices and equities can be traded with
margin and tax efficiently through a spreadbet, surprisingly few investors are
aware that it is also possible to trade bonds (sovereign and corporate) the
same way. In the case of bonds, this has the great advantage of mitigating the
tax liability on any income streams from the coupons, i.e. the coupon is
received in its entirety, gross, rather than receiving net of tax. Further,
ceteris paribas, the income returns can be enhanced through purchasing the bond
on margin.
The above is probably easiest made clear through a description of
my purchase of the Co-op perpetual. The bonds were/are priced at 77p/shr and pay
a coupon of 5.5555p/shr (7.2% yield) until December 2015. So I bought 100,000
of them through ETX Capital at a cost of £77,000. Therefore, I expect to
receive £5,555.50p per annum through to December 2015. However, ETX Capital
offer 25% margin on this line of stock, so the capital which I had to provide
totalled 25% x £77,000 = £19,250. I still receive the £5,555.50p pa, so my
return on equity (ROE) = £5,555.50 / £19,250 = 28.9% pa.
In December 2015, the Co-op can decide whether it wishes to call
them at par (100p/shr) or not. If the Co-op calls the bonds then I’ll get 23p/shr
(100p less purchase price of 77p), or a capital gain of £23,000 and will have
accumulated three lots of 5.5555p/shr in between, an income stream totalling £16,666.50p.
That comes to 39.7p/shr, or a £39,666.50p gain, or a 51.5% (gross) return over
three years. But, because I have bought through ETX Capital, the tax free return
on equity is actually £39,666.50p / £19,250 = 206% (gross) over three years.
Of course the Co-op may decide not to call in 2015 and in that
event the coupon drops from 5.5555p/shr to 3-month LIBOR +205bp. Not calling is
generally discouraged, but it would mean a post 2015 coupon of c. 2.69p/shr (at
current LIBOR). If the bonds aren’t called and the coupon drops to 2.69p/shr,
then I reckon the price of the bond drops to c. 68p. This price would equate to
capital loss of £9,000, but having still received the 5.5555p coupon each year,
the total gain would equate to £16,666.50p - £9,000 = £7,666.50p over three
years. Again, because I have bought through ETX Capital, this is tax free and
the return on equity = £7,666.50p / £19,250 = 39.8% (gross) over three years.
So I reckon that having bought through ETX Capital, the ROE over
three years will be somewhere between 39.8% to 206% . That
appears pretty attractive to me, and I expect the Co-op will call the bonds,
which is why I bought and did so through ETX Capital.
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Co-op 5.5555 08/29/49 perpetual bond |
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