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Is this the beginning of the end for PIBS?

Citywire's Income Investor columnist is wary of building societies starting to 'call in' their permanent interest-bearing shares (PIBS).

 
Is this the beginning of the end for PIBS?

Permanent Interest-Bearing Shares (PIBS) are special shares issued by building societies that pay a fixed rate of interest, a bit like a corporate bond.

Nationwide, Yorkshire, Newcastle, Nottingham, Coventry, Leeds, Manchester and other building societies all have PIBS traded in the market with yields of 6% upwards. Like all fixed-interest securities, the market price is determined mainly by the perceived risk of default and the level of comparable yields, for example from corporate bonds and gilts. However, not all of the yield differential is down to relative strength and security – some reflects the different specific terms of the PIBS issuing prospectus.  

High yield, higher risk

As I always say: higher yield usually goes with higher risk, although you (or I) may not fully understand the nature of the risk.  There have been defaults, as well as near-defaults, such as the Bank of Ireland PIBS. So, DIY investors have to be very wary indeed. But the other risks may be more subtle.

Some PIBS are ‘undated’ or ‘perpetual’ but many have a ‘call’ date (like a redemption date for corporate bonds). In this case, the building societies may have the option of not calling the PIBS but instead applying ‘run on’ coupon terms after the call date which can replace the original fixed rate. These ‘run on’ terms are variable and are typically set in relation to the yield on gilts or Libor. In the current financial climate this would usually be a lower rate that the original fixed yield.

So, for PIBS with a call date, it is possible that one of two things may happen (depending on the specific conditions set out in the original loan prospectus):

  • the face value or ‘par’ may be returned to the security holder (i.e. the PIB is ‘called’), or
  • a ‘run-on’ or ‘step up’ rate may be applied.

Thus the yields – and therefore prices – of callable PIBS and bonds might be significantly affected by whether or not the issuers choose to exercise their calls on the due dates, because with a lower on-going coupon the bond is likely to be worth much less than the 100p call price.

New rules


However, a key change likely to affect all PIBS is the new set of international bank regulatory rules being formulated as ‘Basel III’.  I don’t pretend to be an expert in this process (see here and here for examples of more informed comment) but, as I understand it, it has become much clearer that PIBS will not qualify as part of the required level of Tier 1 or 2 capital (I think the key reason is that these instruments are too inflexible in guaranteeing the coupon payment if the banking institution were to come under pressure).

This means that – in the current interest rate climate – the existing PIBS debt for building societies (and converted banks) will be an expensive non-essential, in terms of the regulatory capital that the institution is required to hold.

One solution for the building societies to adopt, if the run-on rate is low enough, is to fail to ‘call’ the loan and thereby benefit from the reduced borrowing costs. The precedent for this was set by the Principality Building Society in July 2011 by failing to call its 2016 5.375% PIBS and reducing the dividend to only 2.13%, compared with the original 5.375% coupon on the bond (the PIBS will redeemed finally in 2016).

New tactic

However, a new tactic for dealing with the problem has emerged: making a tender offer before the call date, at the market rate instead of at par. This was initiated by Yorkshire Building Society in October 2012 in relation to a number of its securities (as reported by www.fixedincomeinvestments.org.uk), closely followed by the Co-op. Most recently – as reported by Investors Chronicle – Nationwide Building Society (the biggest issuer of PIBS), has made a tender offer for the 6.025% interest-bearing shares, well in advance of the February 2013 call date, amounting to only 88p in the pound. Shareholders are under no obligation to accept Nationwide's bid, but there is a reset option on the shares which could switch the payout rate to just 1.5% above the base rate.

It is not clear whether this approach will be adopted by other building societies: it will come down to their own commercial judgement and the limitations of the issuing prospectuses. So I continue to hold a couple of PIBS with the hope that they may ultimately be called. The end may be nigh but each PIBS is different: the moral is - be careful and do your homework.

If you've enjoyed this article, why not visit DIY Income Investor's blog? The views in this article are the author's own, and do not constitute advice.

12 comments so far. Why not have your say?

David Chapman

Jan 07, 2013 at 15:35

It just goes to show that Financial Institutions are still the devious, double talking, reptiles they always were and always will be - including the "Ethical" Coop !!!

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Codger

Jan 07, 2013 at 16:10

We must give credit to the Building Societies for inserting the call dates and conditions in their prospectuses to cover themselves for the distant and uncertain future. It is just unfortunate that investors never envisaged the banking crisis or the fall in interest rates to the current low levels that have resulted in the building societies implementing their choices at the call dates.

Investors just mis-priced the risk.

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bwanakuba

Jan 07, 2013 at 16:50

Had six PIBs --- and enjoyed lollies for 10 years --- glad sold the lot 3 years ago to buy equities !!!

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Pilgrim

Jan 07, 2013 at 17:15

There is no universal rule governing the financial characteristics of PIBS or other other such instruments, and as the writer points out, the latest gyrations of the the banking community (Basel accords) are likely to reduce the usefulness of the of the issues to the borrowing institutions. Therefore, any investor in a 'PIB' or similar financial instrument should trouble to get hold of the issue prospectus so as to be aware of the distinct associated risks, including the terms for redemption.

Investors should also be aware that the Trust deeds which cover PIB (or other bond) issues generally offers only a very modest level of protection to the bondholder. Indeed, even this limited protection may be cast aside. In the recent exchange offer for the Bank of Ireland Perpetual Subordinated Bonds (formerly Bristol and West Building Society PIBS) the terms of the Trust deed were disregarded. It appears that the Trustee conspired with the Borrower to permit votes then controlled by the borrower to be used to extinguish the residual obligation to the remaining bondholders. This was, and is, impossible under the terms of the Trust deed and it appears to amount to a flagrant criminal contravention of the Fraud Act 2006 by the Trustee. While one might expect the public authorities to intervene in such a case, neither the regulator (who has the duty under the Financial Services and Markets Act (FSMA)), nor the City of London Police who carry primary responsibility for prosecuting Fraud have done so. The FSA has promulgated a web of regulation so complex that it now sidesteps the full scope of the duties entrusted to it by the FSMA. A Police representative explained, unofficially, that a fraud concerning the abuse of a trust deed lay 'outside their comfort zone'. A truly hopeless situation and a victory for fraudsters.

So, PIBS are a great idea and worthwhile investment, but make sure that you understand the risks!

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charles fantham

Jan 07, 2013 at 17:21

what is the future for undated PIBS?

M

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Mark Taber

Jan 07, 2013 at 17:39

My website address referred to in the article is wrong. It should be www.fixedincomeinvestments.org.uk

I have commented on the issues arising from the recent Nationwide tender at:

http://www.fixedincomeinvestments.org.uk/fixed-interest-blog/nationwidestuffsitsretailpibsholdersforxmas

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Chris Marshall (Citywire)

Jan 07, 2013 at 17:46

Mark, that has been corrected

Chris, Citywire

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Pilgrim

Jan 07, 2013 at 17:56

CF

Perpetuals and Permanents are just that for so long as the underlying company remains solvent, and is not taken over or restructured. The market price of the bonds becomes virtually independent of the value for redemption at par for so long as insolvency or redemption are not in prospect.

Recent years have witnessed 'blue chip' companies collapsing, so nothing is absolutely safe, and problems can emerge in even the safest of companies with astonishing speed.

PIBs and other bonds linked to lending institutions are all exposed to an ongoing credit risk. Since the burst in 2008 the West has been trying to reinflate a credit bubble, and official bank lending rates have been depressed in support of this objective. We have made near zero real progress to reduce the levels of borrowing and debt, and the forward prospect for the house market remains dire with a continuing potential for falls in property valuation. The possibility of serious downward pressure on property values continues to pose a risk for the solvency of financial institutions.

So what is the future for undated PIBs? The answer lies in the future of Western economies in general, in the future for the economy of England, and the continuing security of the housing market. No certainties anywhere. But if you are an investor, you must have some faith in the future!

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Mark Taber

Jan 07, 2013 at 18:18

In terms of the future of PIBS I think we can split them into three groups:

1. True perpetual PIBS with no issuer call option or rate reset. These will continue as long as holders want to hold them and issuers do not default. There may be voluntary tender offers in future but it will be up to holders whether they accept.

2. PIBS with a call date and a low reset coupon. As we have seen with the Nationwide 6.024% tender these are likely to be tendered below par prior to the call date using the threat of a non-call to persuade holders to accept. Most will.

3. PIBS with a call date and step-up coupon. These are likely to be called in accordance with Basel 3. Issuers may also tender before call date if they think they do so successfully below par to book a bit of profit.

No new PIBS will be issued. Nationwide are in the process of issuing CCDS which is a new deeply subordinated form of capital which qualifies as tier 1 under Basel 3. But these are quite different and much more risky than PIBS.

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Ines

Jan 07, 2013 at 21:28

Horrible situation for so many people who may have been 'advised' to buy PIBs as low risk, simple investments. I know my mother's stockbroker invested in West Bromwich PIBs for her on that basis. We have to bear in mind now that there is no law that will be enforced around investments if that law is not to the liking of the financial institution concerned, the government is not interested in the plebs.

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MOGO

Jan 08, 2013 at 11:45

Can someone tell me how to view an original prospectus for a PIB. I have tried the issuers web sites and failed.

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Mark Taber

Jan 08, 2013 at 12:10

Mogo - I have links to download most PIBS prospectuses (as well as prices and other key details) in the PIBS table on my website at:

http://www.fixedincomeinvestments.org.uk/permanent-interest-bearing-shares-pibs-table-prices

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