A few years back, Permanent Interest Bearing Shares or Pibs were considered to be as good as gold. UK investors have historically placed great faith in the building society movement and these fixed-income perpetual bonds were considered to be a super-safe home for income-seekers.
The problem is, Pibs are subordinated debt. This means that in the event of a building society being wound up, holders of the security will stand some way down the queue and may not see the return of all their capital. Earlier in the decade, the probability of a UK building society or bank being wound up would have been considered close to zero, but conditions change quickly, as the forced nationalisation of Northern Rock and Bradford & Bingley prove.
Newsflow continues to be negative. The recent re-financing of the West Bromich Building society has seen a new type of instrument emerge - the Profit Participating Deferred Share or PPDS (you can read more about this event on the building society's website). These are a type of quasi-equity and sit below the Pibs on the balance sheet, boosting the society's capital reserves. In theory, this should be good news for the Pibs holders, but the society has decided to cut the coupon on the 6.15 per cent Pibs issue from the summer onwards, dropping the annualised payment down to 1.5 per cent into 2010.
What does the future hold for investors in these Pibs? Understandably, the price has been hit hard, with the instrument trading in the low 20s at the time of writing. The market will want to see the coupon restored if the price of these instruments is to recover and although the West Brom has stated its wish to do this going forward, the situation is complex. The coupon on the Pibs will now be subject to "yield equivalence" with the new PPDS issues, meaning that Pibs holders will receive the lower of either 6.15 per cent or the coupon payment on the PPDS. This is not great news, it means that the Pibs have been "equitised" to a degree, with future payments reliant on the society's profits. What is more, the upside is capped at 6.15 per cent per annum, meaning that Pibs holders have a rather asymmetrical upside/downside.
The changing face of Pibs
So, what next? Bradford and Bingley Pibs coupons have been chopped, although they remain a cumulative liability of the bank. For many years the maxim of this sector was that "no Pibs have ever defaulted", but now that rubicon has been crossed, the suspicion is that we will see a steady increase in the number of issuers looking to skip coupon payments. Prices in the market reflect this fear, with the average price of a Pibs now in the 70s. Quite a few individual issues are trading a fair bit lower than this, and double-digit running yields are now on offer in some cases.
The nature of both the risk and the reward for Pibs is changing. They should no longer be viewed as an alternative to a bank deposit. Instead, the risk is real and present - coupons may be deferred or not paid. In the event of further failures in the sector, capital loss is a possibility. The market price is, however, adapting to this reality and as a result, some tempting yields are available in the sector. We view the asset class as more of a speculative play, perhaps for risk-positive investors who are able to buy three or four different issues and take a punt on the industry recovering.
Two tribes
We would split our attack into two camps - firstly the issues from the ex-building societies such as Halifax and preference and subordinated issues from Lloyds and RBS. These organisations have already been through the mill of government support and re-financing. To a degree, the disaster has already happened, and they are on the road to recovery. The best value issues in this category are the "institutional" issues such as the Bank of Scotland 9.375 per cent subordinated perpetual (Pibs of those societies that demutualised are known as perpetual subordinated bonds). Currently trading around 71p in the pound, the instrument offers a running yield of 13.2 per cent. A more manageable alternative would be the Lloyds 9.25 per cent non-cumulative preference shares at 73p with a running yield of 12.4 per cent, which trades on-exchange with a minimum denomination of just £1.
In the second camp are the Pibs issues from some of the more conservative Building Societies. Consider the issues from Nationwide. Although this building society is by far the UK's largest, the mutual has stayed fairly true to its roots and appears to have avoided the worst of buy-to-let and self-cert mortgages. The Nationwide 7.25 per cent Pibs is now trading at 66, equivalent to a running yield of 11 per cent. The price chart is shown below.
Worth a thought are some of the smaller building societies. Arguably the small size of these organisations makes them more vulnerable, but we would observe that the current global banking crisis appears to have hit the big boys harder than the small, perhaps due to the formers' "sophisticated" treatment of their balance sheets.
Small building societies are typically conservative. The Principality Building Society, Wales' largest mutual boasts a balance sheet consisting of 95 per cent customer deposits - unlike B&B, reliance on the money markets is very low. What is more, the society claims to have a good book of low loan-to-value mortgages and a hefty liquidity book ( liquid funds not lent out as mortgages) of £1.39 billion or 24 per cent of assets. The 7 per cent Pibs issue, however, are trading at semi-distressed levels, circa 49p. Given the 7 per cent coupon, this places the instrument on a running yield of circa 14 per cent, a tempting level for investors looking for a recovery play.
Other articles on Pibs include and
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