In times of austerity, when reliable sources of income are hard to find, Pibs are definitely worth a look. Although they have been through some troubled times in the past 18 months, it is now much easier to assess the risks of Pibs and the challenges facing the building societies, past and present, which issued them. With hindsight, Pibs and their subordinated bond cousins were always more risky than they were assumed to be, but at least investors now can see what those risks are and are being offered an appropriate return for it.
For years, Pibs had a loyal following among the most risk-averse investors, when a lack of analysis in this humble and neglected corner of the fixed-income market just didn't seem a problem. There still isn't much analysis, which makes it a tricky area for private investors, but the yields available are still tempting.
"Pibs offer a high yield and are useful for diversification, as long as you know the risks involved," says William Newman of Evolution Securities.
Those yields are currently in the 7-8 per cent area for the best-known and most solid issues, such as those in Nationwide, the largest building society. That is a far cry from the 10-13 per cent that could easily be earned back in the tailend of 2008, when all corporate bonds were under pressure, but is still above the returns that Pibs had generally offered in the trouble-free 1990s and noughties, where they offered a percentage or two above the equivalent Treasury issue.
Then came the credit crunch. While banks were the principal focus, there were plenty of former building societies among those that lent too much in the wrong areas and with too little capital to adequately cover their exposure.
| What are Pibs? |
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Permanent interest bearing shares (Pibs) are London Stock Exchange-listed shares in current or former building societies, but their characteristics are much closer to bonds than shares. They have a fixed coupon, but unlike most bonds do not have a fixed expiry, so can be thought of as perpetuals. However, most Pibs and subordinated bonds can be redeemed at the issuer's option on fixed dates. Those callable within five years are not eligible for inclusion in an individual savings account (Isa). Generally the coupon is reset to a floating rate if the call is not exercised. However, Pibs are not as good as corporate bonds in their security. On a winding up, Pibs holders rank behind all other lenders, depositors, and all members holding share accounts. Pibs are non-cumulative, which means that if a coupon is unpaid in a given year, the society will not be required to pay any arrears in future. Interest is paid gross twice a year, and is taxable unless within an Isa, self-invested personal pension (Sipp), or similar tax wrapper. Pibs are dealt 'clean of interest', so that accrued interest is settled separately, as it is with bonds. No stamp duty is payable on UK issues, and no capital gains tax is payable on gains. Pibs and subordinated bonds can be dealt only in round amounts, varying from 1,000 shares up to 100,000. You get most of the information you need to know from the title of the Pib – eg, "Manchester 6 3/4 per cent Pibs (call 13/4/2030 @ 100p)" is Manchester Building Society's 6.75 per cent Pib which can be called (redeemed) by the society on April 13 2030 at 100p. Pibs in the demutualised former building societies have been converted to perpetual subordinated bonds, pretty much identical to Pibs in all respects but two. One, unpaid interest on subordinated bonds is sometimes cumulative, so arrears can be made up in future, and two, these bonds will rank ahead of ordinary shareholders. So subordinated shares are definitely safer than ordinary shares in demutualised societies. Moreover, all things being equal, they are safer than equivalent Pibs in a non-converted building society, too, because of the extra cushion of ordinary share capital and dividends which would have been first to be sacrificed before them. However, despite this theoretical advantage, it didn't do the holders of Northern Rock and Bradford & Bingley debt any good. |
Rescues and more
Plenty went wrong. In March 2009 the government rescued Scotland's largest mutual, Dunfermline Building Society. State rescues didn't help subordinated bond holders in Bradford & Bingley (B&B) and Northern Rock, when in June last year it became clear that coupon payments would be missed. B&B holders subsequently failed in a legal attempt to claim compensation as if they were depositors.
Also in the summer of 2009, West Bromwich Building Society cut the coupon on its Pibs to 1.5 per cent. Thinly-traded Pibs were hit hard as cautious investors exited, and some of the smaller societies' issues were avoided altogether. Chelsea Building Society, which in August disclosed $41m of losses in a buy-to-let fraud and $55m in deposits frozen in Iceland, hit Pibs holders hard under the terms of a merger with Yorkshire Building Society. This saw Chelsea Pibs holders lose half their capital, and saw the creation of the first contingent capital (CoCo) instrument for a building society. This was followed by a similar move in April by Newcastle Building Society, affecting one of its three Pib issues.
New rules require more capital
Another area that is becoming clearer is the size of capital cushion that is required for building societies. This is because, uniquely, they do not have shareholders' funds to absorb losses. The latest proposals from the Committee of European Banking Supervisors, which are designed to protect depositors if there is another banking crisis, are highly complex in terms of the structure of hybrid capital (which includes Pibs), but some of the more onerous suggestions on the composition of tier 1 capital in earlier drafts have been removed, according to a research report by JPMorgan.
Competition and the economy
A more obvious but durable threat is the slow economic recovery. Many smaller societies are finding it hard to attract savers at prevailing rates, and fear loss of business to the bigger banks. Some of these are effectively cushioned by taxpayers' money provided at close to nil cost. Dealing with better capitalised rivals is, however, a problem that building societies have long had to deal with. Although they have often been very slow to disclose problems, certainly compared with listed banks, there can be no doubt that they are more carefully scrutinising their liabilities today than they were 10 years ago. So long as the economy does improve, and no new types of problem emerge, the returns offered by Pibs and subordinated bonds look worthwhile.
The most popular issues now are those that are considered solid, such as the Nationwide issues, plus Yorkshire, Skipton and Coventry societies. However, those willing to do a little extra work can find attractive investments in unexpected areas. Research on the quality of the issuer is crucial, but in the absence of analyst coverage it’s a DIY job. Credit rating agencies flag up changes in creditworthiness, but for a real insight a detailed look through the annual report cannot be bettered.
Warning flags might include departures from traditional lending practices, rapid balance sheet expansion, and overexposure to buy-to-let and commercial property (a factor in both West Bromwich's and Dunfermline's problems). As always, a spread of different issues will offer improved risk characteristics in case of an insolvency, but won't protect against the more general deterioration in sentiment that occurs when a society gets into trouble. Although Pibs have not been immune to the backwash of the recent European sovereign debt crisis, they have held up better than many other types of debt. See the table (below) for six Pibs that offer good value.
It is worth bearing in mind that some very high-coupon issues trade well above par (such as the Co-op Bank issue) so the running yield is the only return, and there is a possibility of capital loss on a proposal to redeem. The attractions of the Newcastle issue here reflect the fact that with another issue (the 10 per cent 2008 Pib) having borne the burden in being turned into profit-participating deferred shares, there is now an extra cushion of tier 1 capital to make this issue safer – a fact not yet reflected in the price.
Six issuers’ Pibs offer good value
| Issuer | Coupon (%) | Code | Type | Call date | Offer price (p) | Running yield (%) | Yield to call (%) | Risk |
|---|---|---|---|---|---|---|---|---|
| Nationwide | 61/4 | POBA | Pib | 22/10/2024 | 84 | 7.44 | 8.16 | Very Low |
| Nationwide | 71/4 | POB | Pib | 05/12/2021 | 98 | 7.4 | 7.51 | Very Low |
| Coventry | 6.09 | CVB | Pib | 29/06/2016 | 83.5 | 7.3 | 10.55 | Low |
| Cooperative Bank | 13 | CPBC | Sub | Perpetual | 156 | 8.31 | na | Low |
| Kent Reliance | 6.59 | KRB | Pib | 07/03/2016 | 75 | 8.79 | na | Moderate |
| Newcastle | 103/4 | NBSP | Pib | Perpetual | 109 | 9.86 | 12.89 | Moderate |
Getting to grips with Pibs
Real time prices and yields for Pibs are patchy. The better-known issues, such as most of those for the Nationwide, Co-operative and Yorkshire can be found on a security search on many online brokers. Most have a four letter security code. This is helpful because many issues are confusingly similar. The Nationwide, for example, has seven Pibs that are identical except for coupons which range from 6-7.9 per cent and different call dates.
In many cases, you may have to deal by telephone. The bid-offer spreads quoted are often wide, sometimes 10 points, which reflects the typically thin market for Pibs, but it is quite possible to get inside the spread by setting a limit order a point or two lower than the offer price.
There are few specialist sources of information on Pibs and subordinated bonds. The IC's own Pibs coverage can be found at: investorschronicle.co.uk/bonds. You can also download many of the original issue documents from this page.
For investors in some of the contentious B&B, Northern Rock or Lloyds ECN issues, professional investor Mark Taber has an excellent in-depth site at: fixedincomeinvestments.org.uk/home
| Northern Rock and Bradford & Bingley |
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Northern Rock and Bradford & Bingley recently chose to buy back at a discount a series of subordinated loans. In Northern Rock's case they included mainly dollar-denominated issues totalling £1.33bn which are held by institutions. In B&B’s case they included a series of subordinated loans with a fixed repayment date and two step-up perpetuals with £1.15bn outstanding, but none of the most popular perpetuals offers held by retail investors. Northern Rock Asset Management (which holds the legacy mortgage book, and is now quite separate from the plc) is tendering 25p in the pound, while B&B is offering between 25p and 45p. The price offered is a small premium to the market price, and would offer a substantial premium to those who bought the debt at maximum distress levels, but clearly not for those who have been long-term holders. If Northern Rock could soak up all the issues at this price it will be able to book a £910m profit against the book price, while B&B would make £720m. For these state-rescued legacy banks, propped up by a total of £51bn of taxpayers’ cash, this an important step in the process that may eventually lead to repayment of aid and the sale of assets. That may be moving closer in Northern Rock’s case because in its tender it disclosed a profit for the first four months of 2010. Bradford & Bingley disclosed no new financial information in its tender offer. The bank lost £182m in 2009, £82m less than the previous year. While this doesn't directly impact the remaining subordinated debt issues, it flags an important change of direction, and underlines that the speculative appeal of the deeply discounted issues may have some substance. First, it is clear that the Treasury has managed to get EU permission to spend money reimbursing subordinated debtholders, even though paying interest on these issues is specifically proscribed until state aid is repaid. It will also encourage speculation that offers for other issues may be forthcoming at some stage. |
