Friday 3 February 2012

PIBS: Beware the Unexpected Caller

Just as when you are answering your front door, if you are considering buying a PIBS (permanent interest-bearing share) you need to beware of the unexpected caller. Or more accurately, the non-caller.

Even if you are already holding a PIBS (and some other bonds issued by banks) you should have a good look at your portfolio as there has been a significant change in how these securities are treated which could affect their value.
This issue was highlighted in a recent article on Citiwire.

Readers of this blog should be familiar now with PIBS, which are issued typically by UK building societies and generate dividends twice a year at a fixed rate.

Like all fixed-interest securities, the price you pay is determined partially by the risk of default that the market judges and the level of comparable yields, for example bonds and gilts. So, when interest rates rise, the price of PIBS tends to fall to reflect the higher yield that investors expect and vice versa.

Don't call me, I'll call you

Many PIBS have a ‘call’ date when the issuer can pay out the bond holders at the face value or ‘par’.  The issuer is not obliged to exercise the call, although in the past there has been a widely held 'understanding' that they would be paid off, although legally the calls were in many cases optional - at the choice of the issuer.

Many PIBS therefore have little-known ‘run on’ terms after the call date which replace the fixed rate or coupon on the bond with arrangements that are cheaper for the issuer. These run on terms are variable and are typically set in relation to the prevailing Bank Base Rate (BBR), the yield on gilts or Libor (the London Inter-Bank Offered Rate - the rate at which banks lend to each other).

Until recently PIBS and bonds were generally called when due and investors were paid out. But in July 2011 Principality Building Society set a precedent 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. It will redeemed only in 2016.

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 ongoing coupon the bond is likely to be worth much less than the 100p call price.

Who's calling?

One potential 'offender' may be Santander, whose new debt arrangements imply that it is unlikely to call affected bonds on their due dates. Lloyds Banking Group may be another institution to behave in this way. Nationwide may be the next building society to not call (on its 2013 6.024%). All are obviously free to behave in the way set out in the original loan prospectus and should be expected to behave in their own commercial interest.

These stocks are therefore becoming increasingly volatile and difficult to trade as they approach their call dates. Clearly the nearer the call date the greater the risk. So investors should look at their portfolio and consider making a switch before the call date becomes an issue and affects the price and yield.

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. Could something similar happen to preference shares? I own a few NatWest 9% Prefs - whats the chance the coupon could be cut for example?

    1. It doesn't look like it - but you should find the original prospectus. RBS (who now administer these) issued guidance recently on the conditions under which they could halt dividend payments - but this look remote for these securities