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In our Bond of the Week of 10 April, we took the view that the landslide seen in the price of Permanent Interest Bearing Shares (PIBS) had stabilised, and that these instruments were due for a recovery.
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The instrument we selected for this trade was the Bradford & Bingley 11.625 per cent PIBS. This high coupon bond has no call date, and thus effectively a very long maturity. This means that the bond is highly geared and the chart of the last 12 months bears witness to this effect, with a rapid decline from the halcyon pre-credit-crunch days around 180 down to a recent low at 110.
For this bond, given that there is no maturity date, we calculate the yield in the same manner as the dividend yield on an equity. This is known as the running yield and is calculated as follows:
running yield = par(100)/market price x coupon (11.625)
On this basis the yield has fluctuated from 6.45 per cent back in the summer of last year, to 10.6 per cent down at the April lows. The recent recovery in price has seen the yield diminish to 8.9 per cent.
So, our timing on this call has so far proved to be accurate. But what about the effect of yesterday's £300m rights issue in the shares? The obvious conclusion would be that this is bad news (as it is for the shareholders - one reason we have a sell rating on this company), but a quick check in the market shows the bond trading a couple of points higher than yesterday. This is a classic example of how corporate action can affect different instruments in different ways. Effectively, the shareholders are being asked to dip their hands in their pockets to shore up the company's capital base. Bad news for them, but not so bad news for the happy band of PIBS holders who will end up with a more creditworthy company, at no extra expense to themselves.
So what to do now? Fast trading profits have a tendency to burn a hole in one's pocket, and 20-odd points is a tempting gain in a fixed income portfolio.
On balance, however, we take the view that this security was bought for income, and thus we will continue to hold our position. If a tempting switch was to present itself within the PIBS sector, we would consider substitution.
Bond of the week is supplied by FixedIncomeInvestor and is subject to their standard disclaimer.
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-IC-1.5.4a-prod - 31/10/2008 13:11:34 - carlos.princz
