Mini-Bonds – Too good to be true?

Recently I had an enquiry from an old University friend who is not a client. He got back in touch with me a couple of years ago. He asked me about an ISA he had come across from a company called Capital Bridge. It was offering 9% p.a. interest for three years. My old friend was clearly attracted to this fixed rate bond given the paltry rates of interest on offer from mainstream accounts. However he realised that it was more risky than a traditional cash deposit account as the underlying investments were loans to property companies. That said a salesman who called him after he registered interest seemed confident he would get 9% p.a. over three years. So what did I think?

Looking at the Capital Bridge website the bond offers 9% p.a. interest fixed for three years and is paid quarterly. Investors buy a bond which is held within an ISA wrapper meaning the interest would be tax free. To be fair there are plenty of risk warnings on the website and the downloadable brochure but I couldn’t find a link to the Information Memorandum or Prospectus, a detailed legal document required for the issue of bonds. However Capital Bridge make it clear that capital is at risk and there is no Financial Services Compensation Scheme (FSCS) coverage in the event of default unlike a traditional deposit account. As you are no doubt aware you are covered up to £85,000 if a mainstream bank or building society becomes insolvent. The Capital Bridge bond in terms of investor protection is no different in principle to investing directly in the shares or bonds issued by a UK company. If the company goes bust you may lose all your money and will have no recourse to the FSCS.

To reassure potential investors the website and brochure emphasise the due diligence that is undertaken in making loans to property developers and the security that is taken, notably the charges taken on the relevant properties. Phrases like hand-picked UK property developers, significant security and strict criteria suggest care and safety. Personal guarantees are taken from directors, loans are no more than 80% of the value of the property and they are valued by a Royal Institute of Chartered Surveyors surveyor.

To be fair it is made clear the security taken over the properties may be insufficient to repay bondholders and that property is an illiquid asset and the bonds may be difficult to sell. Oddly though it is stated that the investment into a Capital Bridge ISA should be a long term investment but I would not consider three years in any sense to be long term. The point is investors in the bond not only expect 9% p.a. interest for three years but a full return of capital at the end of the term. Where will Capital Bridge derive the cash to fully repay bondholders? All the loans will need to have been repaid in full at the right time. This in turn may require the properties to be sold at good values. Both are big asks.

There are plenty of other concerns about the product. Firstly interest payments are not guaranteed as these depend on interest payments made by the property developers. Secondly Capital Bridge is the trading name of Capital Bridge Bond Co 1 Ltd. It is not authorised and regulated by the FCA. Capital Bridge then pass investors’ money to a related company called Capital Bridge Finance Solutions Ltd (CBFS) who in turn make the property loans and take security on the assets. CBFS are also not an FCA firm. However the underlying investment is held within an ISA provided by Northern Provident Investments who are FCA regulated. That in of itself does not give legitimacy to the underlying investment nor provide investor protection. The ISA manager merely confers a tax free status to a unregulated investment and administer the interest payments. They have no liability for default for the underlying investments. Herein lies one of the problems of regulation, that an unregulated investment can be held within an ISA which is a regulated wrapper. It is similar to the position IFAs find themselves in. If I recommend a client buys an investment trust or exchange traded fund (ETF) for their ISA there is a confusing mix of investor protections. The advice I give is regulated, the ISA plan manager is regulated but investment trusts and ETFs are not and investors have no recourse to the FSCS if the investment goes bust, unless an adviser gave bad advice and the IFA firm itself is in default.

Interestingly the enquiry from my old university mate came at a time when a company called London Capital & Finance (LCF) no long earlier went into administration. They offered a similar 8% p.a. fixed rate bond held within an ISA. There is a page on it on the FCA website:

Also you may have listened to Money Box on BBC Radio 4 last Saturday which covered this story. Around 14,000 customers had invested around £214 million into the bond. Investors may get little or nothing back once the administrators and other debtors get paid. While the asset backed nature of the Capital Bridge loans are different to those made by LCF both are mini-bonds and carry the same risks. The FCA write:

“A mini-bond is an unlisted debt security, typically issued by small businesses to raise funds.

Mini-bonds can be attractive to investors because of the interest rates on offer. However, prospective investors need to understand the associated risks. Mini-bonds are usually illiquid as they are not transferable, unlike listed retail bonds, which they are often compared to. They can also be high risk, as the failure rate of small businesses can be high. Additionally, as with the issue of other non-transferable corporate bonds, there is no Financial Services Compensation Scheme (FSCS) protection if the issuer fails.”

Another concern lies with the fact that the bonds are issued Capital Bridge Bond Co 1 Ltd. They will have very limited assets of their own as they have passed over investors’ cash to a separate legal entity CBFS. I could write more but in conclusion I would not invest in such a bond myself and would actively dissuade my clients from doing so. It looks too good to be true. There are simply too many concerns and risks for me, whilst better investments exist elsewhere. Structured deposits or structured capital at risk products are options for high potential returns along with adventurous equity funds. I plan to write about the former at a later stage.

The content of this blog are my own thoughts and assessments. Nothing in this article should be construed as personal investment advice, for example to invest in structured products or equities. You should seek individual advice based on your own financial circumstances before making investment decisions.