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Pibs, the asset class of the moment

Created:

28 November 2008

Written by:

Mark Robinson

One of the key investment themes of 2009 is going to be the aggressive reduction of central bank interest rates - and while rate cuts aren't always passed onto borrowers, they are almost always passed onto savers. One potential home for an investor's cash in such a low-yield environment is permanent interest-bearing shares, or Pibs.

Pibs are deferred shares that pay a fixed rate of interest over an indefinite period. They are essentially a form of subordinated debt, and have traditionally been used by mutual building societies, who cannot raise funds on the stock market like a bank. Holders of Pibs are actually members of the issuing building society from a legal perspective, just as borrowers and savers are, and are consequently entitled to voting rights. Pibs issued by the demutualised building societies are known as Perpetual Subordinated Bonds (PSBs).

Rik Edwards, a fixed interest specialist at stock broker Collins Stewart, makes the point that: "Low interest rates always strengthen demand for fixed interest stocks, but I would qualify this by saying that Pibs and preference yields are ultimately more closely related to gilt yields than short term interest rates, reflecting the long maturity or undated nature of most prefs and Pibs."

While a few floating rate Pibs have been issued, investors should be aware that the interest they receive is generally based on the coupon rate at the time of purchase. This is what makes many Pibs so attractive; they were originally issued at a time of high interest rates, yet prices have been pushed down by worries about the health of the financial system generally.

Interest

Gross interest payments on Pibs are usually made twice yearly, but are only available after payments have been made on ordinary savings accounts. Payments cannot be made if it would mean that the society would breach its capital adequacy guidelines. Although additional Pibs can be issued in lieu of a cash dividend, it is worth noting that interest payments are generally non-cumulative, so in the event that a society fails to make a payment, no obligation is carried forward.

Taxation

Pibs are traded clean of interest, so any accrued interest has to be settled separately. Income tax is due on the income, but you can negate the liability by nesting them in an Isa or a Sipp. Pibs are subject to special tax provisions, so a gain accruing on the disposal of Pibs is not a chargeable profit for capital gains tax purposes.

Security

Pibs offer attractive yields, but you have to remember that they are not as secure as bonds. If the issuer was to go belly-up, then the subordinated nature of Pibs means that they rank behind all other creditors and depositors in terms of interest repayment, and also those members holding share accounts. Furthermore, they are not covered by the Financial Services Compensation Scheme. This can have an effect on prices, as holders of Bradford & Bingley PSBs know to their cost (the UKSA has started a campaign over the poor treatment of PSB holders). B&B PSBs are now trading way below par, reflecting the uncertainty over their fate. Pibs are generally irredeemable to investors, although some issues can be called at the building society's option, usually with a penal interest charge.

Trading Pibs

Commission rates for buying and selling Pibs are broadly similar to those for other fixed interest securities. Liquidity can be an issue, and that's often reflected in wide bid-offer spreads. Many Pibs are only tradable in relatively large, pre-set tranches, so you often need to commit a substantial sum when investing. Also, bear in mind that while Pibs are in demand now, when interest rise, their fixed interest rates mean buyers are thinner on the ground. Right now, Mr Edwards believes that the Britannia 5.555% and Nationwide 6.25% issues offer good value.