We have identified a medium term Aa3 rated Royal Bank of Scotland (RBS) bond maturing 10/18/17, denominated in the Norwegian kroner and are targeting a better than 5.65% yield for our clients.
Corporate Bond linked to the Norwegian Kroner
The Royal Bank of Scotland has bonds denominated in Norwegian krone with a current yield of over 5.65 % for 75 months. This is a significantly better yield than we previously thought obtainable for an investment grade debt instrument in what is historically one of the world’s strongest economies and currencies typically included in prominent global diversification funds and ETF’s, and we see it as a savvy opportunity for inclusion in our Foreign and World Fixed Income holdings as further diversification protection against the continued erosion of the dollar’s buying power and status as the world’s reserve currency. While the US dollar strengthened recently in the wake of the Greek financial crisis and its impact on the euro, the Norwegian kroner appears to have very convincingly held its ground against the dollar in spite of much weaker oil prices, and its currency exchange rate remains firmly on a 10 year bullish trend against the dollar. Slightly over two years ago, banking giant HSBC analysts dubbed the Norwegian krone “The World’s Safest Currency.“ Last week, HSBC’s chief FX strategist David Bloom stated the belief that “there is no better currency than the NOK.”
Norway, like Switzerland, isn’t a member of the European Union and will post a 12.5 percent budget surplus of gross domestic product this year according to the Organization for Economic Cooperation and Development. The country’s Financial Supervisory Authority stated last week that Norwegian banks had “insignificant” holdings in Greece and limited capital placed in Ireland, Portugal, Spain, and Italy. Norway is the second richest country per capita in the world. Although Norwegian krone and the Norwegian economy isn’t big enough to become a safe haven for many large institutional investors, the strength of the currency mixed with a longer maturity date works extremely well with our laddering strategy to diversify clients away from heavily weighted US dollar based assets, and it is why we have chosen it for This Week’s Best Bond.
US Debt Woes
After acquiring $1.7 trillion in securities through last year and increasing the amount of money in circulation in order to prevent deflation, the central bank’s $600 billion buying program ended last week. U.S. debt outstanding has grown to $9.26 trillion in marketable Treasuries, equivalent to about 66 percent of gross domestic product, from $4.34 billion in mid-2007, before the recession and collapse of Lehman Brothers Holdings Inc. However, Wall Street’s biggest bond traders appear to be sticking to their forecasts that government bonds will fall as the economy recovers and concerns over a European debt crisis recede. According to a Bloomberg News survey of the 20 bond dealers that serve as counterparties to the Federal Reserve in its open market transactions, they expect yields on the ten year Treasury notes to rise to 3.5% by the end of 2011. The 20 firms have a negative $44.5 billion position in T-notes and bonds, compared with the negative $11 billion average of the last 3 years. Evidently, QE2 succeeded in driving investors into riskier assets.
Interestingly, US Treasuries have outperformed all of the G-7 debt in the first half of this year, with the U.K. returning 1.78 percent, Canada 1.79 percent, Italy 1.68 percent and Japan 0.6 percent. German and French debt left investors with losses. Sputtering economies with yields near record lows have clearly frustrated fixed-income investors looking for more return.
Norway is one of the world’s most prosperous countries, and is ranked 16th in economic freedom out of 43 countries in the Europe region. In general, Norway’s economy was shielded from the worst of the global credit crisis due primarily to its extensive oil wealth (world’s sixth-largest oil exporter), a strong labor sector, a stable housing market and a mainland economy that is expected to continue expanding at a somewhat moderate pace. The country is richly endowed with numerous natural resources including hydropower, fish, forests, and minerals in addition to its already noted petroleum sector, which accounts for nearly half of exports and over one third of state revenue. In anticipation of eventual declines in oil and gas production, Norway saves state revenue from the petroleum sector in the world’s second largest sovereign wealth fund, valued at over $500 billion in 2010.
After solid GDP growth in 2004-07, the Norwegian economy slowed in 2008, and contracted in 2009 before returning to positive growth again in 2010. It features a combination of free market activity and government intervention, with the government controlling key areas, such as the vital petroleum sector, through large-scale state-majority-owned enterprises. Norway opted to stay out of the EU during a referendum in November 1994. However, as a member of the European Economic Area, it contributes sizably to the EU budget.
In its latest economic trends report released last Thursday, Statics Norway revised the nation’s gross domestic product forecast for the year 2011 upward to 2.3 percent from 2.1 percent, expecting to see stronger growth this year mainly as a result of robust domestic demand. According to the statistical office, the cyclical upturn in the economy will contribute to an increase in employment and real wages in the coming months and also revised the inflation forecast for this year up to 1.9%, citing higher inflationary pressures arising from solid gains energy costs. The consumer price index, adjusted for tax changes and excluding energy products, is forecast to rise 1.3 percent For 2012, the overall economy is projected to grow 2.8 percent, with the Mainland economy expanding up to 4 percent. The consumer price index outlook for 2012 was left unchanged at 1.7 percent, and the headline inflation forecast was cut to 1.3 percent from 1.5 percent
The unemployment rate in Norway has fallen to 3.3% as the economy has bounced back from a shallow recession in 2009, and with those hiring chasing fewer candidates, wages and therefore inflation could rise. The Norges Bank traditionally is a flexible inflation fighter, balancing inflation and growth. While set to hold key rates at 2.25% this week, there are concerns that future rate increases may be necessary to manage the strong labor market and wage growth. However, raising Norway’s rates while others remain on hold would strengthen the kroner, hurting the competitiveness of Norway’s exports. The kroner has risen about 12% versus the U.S. dollar over the past year, and a stuttering U.S. recovery has weakened expectations that the Federal Reserve will raise rates any time soon.
The Royal Bank of Scotland (RBS)
The Royal Bank of Scotland was founded in 1727. In the twentieth century it expanded rapidly, acquiring several English banks, and after embracing computerization and introducing a new generation of multi-function cash dispensers in the 1970’s, by the 1990s it was at the forefront of telephone and Internet banking. In 2005 it formed a strategic partnership with the Bank of China and, two years later, in the biggest takeover in banking history, led a consortium to acquire the Dutch bank ABN AMRO. The crisis in global financial markets and deteriorating economic conditions across the world weakened many financial services organizations, and RBS was no exception. Certain major strategic decisions were costly, and a disappointing performance in 2008 may have masked a stronger underlying performance and profitability in all but one of their businesses.
In February 2009, RBS set out on a five-year Strategic Plan to guide the restructuring of RBS to make it safer, stronger and more efficient for customers. The plan was built around strengthening their Core businesses while winding down and exiting the businesses they decided not to retain long term (Non-Core.) In March of 2011, Standard & Poor’s attributed an upward revision of standalone credit ratings to the good progress made in executing RBS’s restructuring program, citing a significant reduction in non-core assets and an improved balance sheet, which have strengthened its funding and liquidity position and contributed to improvements in its risk profile and earnings. Also noted in their view of RBS’s creditworthiness is their continued benefit from “significant extraordinary support” from the U.K. government, including an 83% ownership stake.
Funded non-core assets for RBC declined to £138 billion at year-end 2010 from £258 billion at year-end 2008, and the reported loan-to-deposit ratio fell to 117% at year-end 2010, with outstanding short-term wholesale funding now matched by RBS’ liquid asset holdings. RBS reported a £1.9 billion pretax operating profit in 2010, which was a material improvement from its £6.1 billion loss in 2009. Further progress in expected for 2011 as non-core impairments continue to decline. In absolute terms, however, RBS’ earnings remain a rating weakness, and it has some way to go to achieve its target of a 15% return on equity from its core businesses in
2013. The government’s capital injections and the insurance it provides under the Asset Protection Scheme (APS) underpin RBS’ capitalization through the restructuring period.
According to RBS’ May 6 Q1 report, their Non-Core division is on track to reduce its funded assets to less than 10% of the Group total by the end of 2011 and the Group’s Core Tier 1 capital ratio improving to 11.2%. Their current credit ratings are Aa3 from Moody’s, A+ from Standard & Poor’s, and AA- from Fitch.
The default risk is RBS’s ability to perform. Given their restructuring progress and improved performance, as outlined above, and the medium term maturity of this bond, it is our opinion that the default risk is minimal relative to the modest return.
The currency risk could and will affect the returns of these bonds and possibly in a negative way as it exposes investors to the Norwegian economy.
The Norwegian kroner has gained 5 % against the euro since a November low, but because 80 percent of Norway’s exports go to the European Union, the kroner remains connected to the euro and would be affected in the advent of a Greek default. Though Norway’s banks hold little in the way of Greek debt, the fallout of a Greek default on banks in Germany and France would pass through the whole region and hit even Europe’s richest economies.
How can investors participate in Norwegian krone denominated bonds? Achieving an institutional sized yield typically requires an institutional sized bond purchase. To facilitate attaining a more attractive yield, here at Durig Capital we bring together many retail bond buyers into a single much larger institutional sized trade. In this week’s syndicate, we anticipate being able to accommodate purchases as low as $ 5,000 US Dollars should that the level that best fits with your interest. So the answer to the question is simple – contact your Durig professional.
Indications of a slow or modest US economic recovery remain very fragile and sensitive to oil prices. Considering that higher oil prices will likely correlate into an added boost to the krone’s strength relative to the US dollar and numerous other global currencies, there may be significant potential for a longer term capital gains advantage residing in the currency exchange for the Norwegian kroner. Therefore, we view the currency risk of this leading European economy as an intelligent choice that we have recommend our clients take in their continued effort to diversify away from overweighted US dollar based assets, and it is why we are adding it to our Foreign and World Fixed Income holdings.
Disclosure: Durig Capital clients may currently own these bonds.
To know more about this Bank of Scotland bond call our fixed income specialist at 971-327-8847