Is my Royal Bond with RBS safe?

By PHILIP SCOTT
Updated:

 

'I recently saw RBS advertising a Royal Bond to investors but now I have heard that both it and Lloyds Banking Group will be barred from paying bond coupons. Will this affect the Royal Bond and is it bad news if I'm thinking of investing in corporate bonds?'

Bank vault, safe

Bank bond investments: Are they safe?

Philip Scott at This is Money replies: Royal Bank of Scotland and Lloyds Banking Group have both been barred from paying income, or coupons, on bonds for two years. This comes as part of their massive fund raising backed by the Government.

However, this development will have no impact upon the regally entitled and recently launched RBS Royal Bond.

This was targeted directly at investors, paying a 5.3% annual return with no exit penalties, and the group assured This is Money it is operating normally.

After prolonged negotiations with the European Commission, over the amount of state aid both Lloyds and RBS have received, the firms unveiled a catalogue of forfeits they must comply with.

These include a crackdown whereby anyone earning more than £39,000 could not receive cash bonuses and that executive directors would have bonuses deferred for three years.

In addition, the banks will be barred for two years from January 2010 from paying coupons on bonds, unless there is a legal obligation, as there is with the Royal Bond.

Investing directly in corporate bonds is rare for private investors. It is typically an activity for large institutional investors such as pension funds and bond funds run by asset management firms, such as Invesco Perpetual - the UK's biggest fund manager.

Millions of small retail investors, however, will have savings in bond funds and funds with bond investments, given that since the financial crisis began corporate bond funds have been a top-seller.

Bonds are a form of IOU. Governments and companies issue bonds as a means to drum up cash. Less volatile and safer than shares, corporate bonds are essentially a cash loan to a company. In return, the firm pays out a fixed rate of interest and agrees to return your money on a set maturity date.

Bond funds will have a very wide spread of bond investments, typically more than 100 holdings, so even if a bond fund does have exposure to Lloyds and RBS, this does not mean that savers are at risk. The fund manager may opt to sell the bonds on in the secondary market, and invest in other bonds still paying coupons instead, or just wait until they mature and realise the cash.

If RBS or Lloyds go bust (which seems highly unlikely given the efforts the Government has gone to in order to keep the banking system afloat), bond holders sit high on the priority creditor list, after preference share holders and ahead of normal shareholders. Provided the banks don't go bust the bonds will ultimately pay out, they just will not pay any returns for the next two years.

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