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Bradford & Bingley Pibs tempting

Created:
10 April 2008
Written by:
Mark Glowrey

At the risk of stating the obvious, it has been a pretty volatile time for banks, building societies and related financial sector players. Many formerly "blue chip" bank shares have seen the value of their equity halve over the past 12 months, whilst the credit crunch has adversely effected their ability to borrow, pushing up the yield on financial sector bonds.

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The Pibs (permanent interest bearing shares) sector has been no exception. These subordinated instruments carry a higher risk* than conventional bonds whilst their undated status means that the price volatility will be higher. Price movements have been dramatic. A year or two ago investors were happy to accept yields of just over 5 per cent to hold these instruments; in the current environment, yields of 8-12 per cent is considered an acceptable return. Thus, in some cases, the yield has doubled, and the price has halved.

The price of Pibs has been falling for over a year, and our strategy has been to ease ourself into the rising yields, picking up holdings for the model portfolio over a period of time. To date we had purchased two £5,000 holdings of the Portman (now part of Nationwide) building society 7.25% Pibs at price of 97.5p (August 2007) and 85p (Feb 2008).

Reviewing our holding last week we noted that the price of these instruments appears to be steadying for the moment. We continue to be tempted by the high yields available in this sector, but our appetite is moderated by the need to keep our model portfolio adequately diversified. One Pibs that caught our eye was the Bradford & Bingley 11.625 per cent. This security was issued by the then building society in 1992 at a price just over par, and became a liability of B&B PLC as the organisation de-mutualised. With interest rates falling over the past decade, the price rose and 2006 saw the instrument trading at the heady heights of 200p, effectively halving the yield available from the 11.625 per cent coupon to 5.8 per cent. Nowadays the price is languishing around the 112p, still a slight premium to the issue price, but in our view a reasonable trade-off against the high coupon. The running yield at that price will be 100/112 x 11.625 per cent, a tempting 10.4 per cent.

*A subordinated bond is an issue which carries less seniority in the "pecking order" of the company's balance sheet. When times are good, this will make little difference, but in the event of the issuer hitting hard times, the coupon payment on certain classes of subordinated debt may be waived. Also, if the issuing company is forced into liquidation, subordinated debtholders will only be paid out once senior debt has been repaid (although they'll still be paid before equity shareholders)

MARK'S VIEW:

Buy

There is another reason that we like the B&B Pibs; the issue is not callable. This means that we can benefit from a 10 per cent yield for life. What is more, should interest rates decline (or stay low), and the banking sector recover, it is likely that this instrument will see a good recovery in price.

The minimum denomination for this Pibs is £10,000. This is a fairly large chunk for our £100,000 model portfolio. Accordingly, we sell half our Nationwide holding at a price of 90p, taking a small profit on our second purchase. We buy £10,000 of the B&B issue at price of 112p.

Bond of the week is supplied by Investors Intelligence and is subject to their standard disclaimer.

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