Pibs: A tempting offer for income seekers

Permanent interest bearing shares (Pibs) often offer temptingly high returns. But before you buy, you need to be aware of the risks. Piper Terrett explains.

Income-starved investors might be excited to know that they could get yields in the region of 6% from their local building society. But these aren't accounts they're IOUs issued by the societies, and like any other high-yielding asset, they carry significant risks you need to be aware of before you consider buying.

"Permanent interest bearing shares" better known as Pibs are similar to bonds, but are issued by building societies to raise funds. They usually pay out a fixed rate of interest each year, and are traded on the stock exchange. However, unlike bonds, Pibs do not usually have a redemption date on which the issuer must return investors' capital (though some give the issuer the right to buy at a future date which is something you must take into account if you consider investing in them, as we'll see in a moment).The yields on Pibs can be tempting.

For example, one Bank of Ireland Pibs yields 6.5%, while Nationwide has Pibs offering yields of 5.7% and 5.4%. But as you might expect, given the rate of return, Pibs are risky. The biggest and most obvious risk is that of the issuer going bust. During the financial crisis, several building societies went under, so don't think for a moment it can't happen. If a mutual does go to the wall, Pibs are ranked as subordinate debt, so holders are at the end of the queue when it comes to getting their money back. In other words, they probably won't get any. So take a look at a building society's balance sheet before you make any decision on buying.

But insolvency isn't the only thing you need to beware of. Watch for Pibs with specific conditions attached. Some have "call" options, which means they can be bought back at a specific future date. This is quite likely to happen, given that outstanding Pibs generally have high interest rates relative to today. If this is the case, you need to look at the "yield to call" on the Pibs this would be your total annual return taking account of the fact that the Pibs is likely to be redeemed at its face value of 100p (in other words, you're likely to make a capital loss, so you have to make sure your income would compensate for that).

And as with any other high-yielding asset, Pibs have seen their prices shoot up and their yields fall in recent years as investors look for income. That means that when, and if, interest rates finally rise, Pibs will become less attractive to investors and prices could fall hard. Pibs with no call date would be hit hardest, as this makes them extremely sensitive to changes in interest rates (they are "long duration" investments, as the City jargon has it).

Finally, Pibs are not particularly liquid so if you do invest, watch the bid-offer spread (the gap between buying and selling prices) and be aware that you may find it hard to sell for an acceptable price if you do want to offload them in the future. Interest on Pibs is usually paid gross, so if you can, it's worth holding them in an individual savings account.

Dangerous pitfalls

The bonds that Lloyds offered in exchange are known as enhanced capital notes (ECNs) and pay interest rates from 7.5% to 16%. Switching Pibs to ECNs benefited Lloyds as the ECNs could be converted into shares if needed in order to boost the bank's capital. That's why Lloyds was prepared to offer such a high interest rate in order to complete the exchange. The issue of the ECNs was overseen by regulators and the Treasury, who were aware that many of the bondholders were retail investors a fact that sits awkwardly with a subsequent decision to ban similar instruments being sold to retail investors on the grounds that they are too risky and complex.

Investors believed the ECNs would mature between 2019 and 2029. But Lloyds no longer requires the ECNs to count towards its capital requirements, so has decided to interpret the ECN conditions in a way that allows it to redeem the ECNs early. Whether its interpretation is correct is the subject of the court case. In the event that the bondholders lose, there must surely be questions about the authorities' role in persuading retail investors to take part in the ECN exchange especially given that the state would otherwise have had to bail out Lloyds directly.

Popular Pibs
StockPrice (p)YieldIssue sizePay dates
Bank of Ireland 13.375% (no call)2066.50%£46mMarch & November
Coventry 6.092% (call 29/6/2016)105.55.80%£120mJune & December
Leeds 13.375%2156.20%£25mJanuary & July
Nationwide 6% (call 15/12/2016)105.55.70%£60mJune & December
Nationwide 6.25% (call 22/10/2024)1155.40%£44mApril & October
Principality 7% (call 1/6/2020)1066.60%£60mJune & December
Skipton 6.875% (call 13/4/2017)106.56.50%£50mApril & October
Skipton 12.875% (no call)2056.30%£25mJanuary & July

Correction: this table originally indicated that the Leeds 13.375% Pibs were potentially subject to a call on 6/2/2018. This was incorrect there is no potential call on this PIBS. Our apologies for any confusion caused.

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