Solid Bonds – Higher Yields

Evan Liberman Articles, Corporate, Ideas 1 Comment

If you're like many investors, you like the safety of Israel government bonds. It's considered the most solid Israeli security, but in today's low interest rate environment, the yields are somewhat modest at 2% to 5% per year. This type of return begs the question - how can one increase the yield of their bond portfolio without adding considerable risk?

One suggested way to do this is to add bank bonds. Bank bonds issued by the top two Israeli banks (Bank Leumi and Bank Hapoalim) are highly-rated by the Standard & Poor's rating agency (A+ to AA+). These bonds typically give 1% extra yield over their government bond counterparts, factoring in that they are corporations and not the government. So, by augmenting your portfolio with bank bonds, you increase the overall yield. While the leading Israeli banks are limited liability companies, and can theoretically delay or default on interest or principal payments, the chances of an Israeli bank defaulting are slim. Even in the recent global banking crisis of 2008-2009, Israeli banks didn't default on their bond payments or go bankrupt, and therefore did not require any bailouts.  Their international sub-prime mortgage loan exposure was low due to the strict banking regulatory environment, and such risky loans didn't even exist (and still don't) in the Israeli real estate market. The Government of Israel also gave an implicit backing of the banks to indicate to the markets that Israel wouldn't let it's banks fail.

Bond types

There are three primary types of corporate bonds: fixed-rate, adjustable-rate and inflation-indexed. Both Bank Leumi and Bank Hapoalim offer bonds from each type.

Fixed-rate bonds tend to yield the highest levels of interest, but are more subject to price decreases when interest rates rise. Long duration fixed-rate bonds should be avoided if you plan to redeem your bond before full-maturity.

Inflation-indexed bonds adjust according to the Israeli Consumer Price Index (CPI). Israel's current inflation rate expectation is 3%. Therefore, when you buy an inflation-indexed bond, you receive the listed interest rate (such as 3.5%/year) plus the inflation index (for example, 3%/year). In this case, your annual effective yield would be 6.5%.

Adjustable-rate bonds pay a variable interest rate, depending on what the government interest rate is at the time. For example, if you purchase an adjustable Bank Leumi adjustable-rate bond listed at 3.6% now, and three months from now the Bank of Israel raises interest rates by 1%, your bond will pay you interest at the rate of 4.6%. This continues during the whole life of the bond. As we're experiencing historically low interest rates globally, experts believe the only reasonable direction for interest rates to go is up. Currently, the Bank of Israel interest rate is 2%, but we could easily see it at 6% in a few years time. At that time, the same bond would pay a 9.6% yield yearly. Therefore, adjustable-rate bonds are recommended by many experts today.

Suggested bank bonds

Here are a few suggested bonds of each type from Bank Leumi" (Leumi Finance") and Bank Hapoalim ("Poalim Offerings").

[TABLE=24]

Current Yield to Maturity, the best measure of real rate of return, and even more bond details, can be viewed using the Google-translated Bank Leumi website (the translation to English is problematic).

Ratings

There are two internationally-recognized bond rating agencies that examine Israeli companies' ability to repay their debts: Standard and Poor's and Moody's. Listed below is the meaning of each of their rankings. The S&P's rank can add a fine tuning of + or -; Moody's can add a fine tuning of 1,2 or 3 to better rank a bond within a specific category.

[TABLE=16]

More details on the banks

[TABLE=21]

Comments 1

Leave a Reply