Many investors are looking for income as current bank deposit rates of around 4%-4.5% are insufficient for their needs.
So when corporate bonds such as the two being offered from Insurance Australia Group (IAG) and Contact Energy come on the market with interesting interest rates, there is a considerable rush to invest.
IAG is the parent company in New Zealand of State and the New Zealand Insurance Companies. It has seven different brands in Australia such as NRMA and other companies in Asia and the United Kingdom. Contact Energy was formed in 1996 from parts of the Government-owned Electro Corp and became publicly listed in 1999. It is 51% owned by Origin Energy of Australia.
The offer from IAG is to be at least 7.5% when it closes on December 12 and the Contact Bond is 8% closing on December 15. Both will pay interest quarterly with the interest reset after five years. (15 December 2016 for IAG and 15 February 2017 for Contact.) The Standard and Poors rating on the IAG offer is A- and for the Contact Bond is expected to be BB-. Both are unsecured subordinated debt securities.
The interest rates make these offers attractive and are already fully subscribed with Contact wanting $150 million (with the possible $100 million extra also going because of demand) and IAG has already increased the offer from an original $150 million (plus $100 million extra) by another $75 million to a possible $325 million. Minimum investment is $5000 in both.
There is a catch in that the IAG offer is a 25-year bond and Contact's is for 30 years. Both are callable on or after the first reset of interest date. (See above). That means the issuers can repay the bonds at any time after the reset dates. Many investors are put off by the length of time to maturity. However, what many investors do not realise is that there is a New Zealand secondary market in fixed-interest securities that operates every business day.
More than a hundred different items are now for sale, ranging in interest rates from 3.6% to 10.5% from the Government through to banks and companies. These are the interest rates that were offered when the securities first went on the market. These are known as the coupon rate.
However, when buying or selling a fixed-interest security there is a second interest rate set by the current market levels, know as the yield. Yields are now around 3%-4.5% for good-rated securities but up to 8% for unrated offers. So if buying on the secondary market at the moment there is a cost because you have to make up the difference between the coupon rate (the rate you will receive in interest) and the yield (the true market interest rate).
For example a popular Fonterra bond maturing in March 2015 has a coupon of 7.75%. The yield today is 4%. The cost of purchasing $10,000 is $11,316 including $168 of interest since the last quarterly payment on 10 September. The security issuer does not make part payments of interest.
In the case of the IAG and Contact bonds above, you are investing at the coupon rate. You could sell after you have purchased them for a profit as others seeking income will buy them on the secondary market and hold them to maturity or perhaps at least until yield interest rates begin to rise after the Official Cash Rate has risen.
Investors know it pays to spread your investments to reduce risk. Talk to your financial adviser to see if an investment in either of these two bonds is suitable for your income needs.
• Peter Smith is an authorised financial adviser and a certified financial planner and is the principal of Kepler Group Otago Ltd, Dunedin. Email: pete@keplergroup.co.nz . A disclosure statement is available on request and free of charge.
