Nationwide's PIBS replacement is very risky
A new bond from the UK's biggest building society might pay 7% a year, but is highly risky!
Nationwide Building Society has plans to sell a new high-income bond to its members. Alas, this bond is not a savings account and is much riskier than it first seems.
Not your usual bond
The bond is a new product called Core Capital Deferred Shares (CCDSs).
The attraction of CCDSs is that they pay much higher rates of income than traditional savings accounts and fixed-term savings bonds. Then again, this extra interest comes at a price, because these CCDSs are far riskier than traditional deposit accounts.
CCDSs are Nationwide's replacement for PIBS, the Permanent Interest-Bearing Shares issued by building societies to raise extra capital. The latest edition of the Financial Times lists the details of 40 PIBS from 17 different societies and ex-societies, including eight from Nationwide BS itself.
However, as with shares in listed companies, Permanent Interest-Bearing Shares are a much riskier bet than cash deposits. Indeed, they are much closer to corporate bonds or shares than savings accounts.
In theory, PIBS are fixed-income investments, which mean they pay a fixed interest rate throughout their lives. However, like company shares, their capital value can fluctuate -- depending on general interest rates, inflation and other factors. Thus, it is possible to lose money by buying PIBS at a higher price than you later sell them at.
In addition, many PIBS investors have discovered to their cost that the fixed income they pay is far from guaranteed, too. For example, PIBS issued by bailed-out banks Bradford & Bingley and Northern Rock have failed to pay out any income for two years, after B&B failed to pay the half-year PIBS coupon due on 20 July 2009.
In short, PIBS were once seen as a low-risk, secure way to earn a decent income on your spare cash. However, since the global financial crash of 2007/09, the real risks of PIBS have been brutally exposed.
Here are five reasons why most sensible savers should avoid PIBS -- and CCDSs, Nationwide's new replacements -- like the proverbial plague:
1. No savings safety-net
With a deposit account, 100% of the first £85,000 of cash per person per institution is protected by the Financial Services Compensation Scheme (FSCS). Hence, if a bank or building society gets into trouble, then the FSCS will step in to protect savers' money up to this threshold.
However, unlike conventional savings accounts, PIBS are not covered by the FSCS.
2. Low liquidity
Liquidity is a measure of how easy it is to buy and sell an asset. Obviously, cash is the most liquid asset, as it can be exchanged in any size as payment for goods. However, PIBS are highly illiquid securities, because they are thinly traded. Thanks to this lack of liquidity, selling PIBS can be very difficult, especially when financial markets are going through one of their periodic panics.
3. Broker charges
As fixed-income investments, PIBS cannot be bought in building-society branches. Instead, you must trade them via a stockbroker, which means paying broker commissions when you buy and sell.
4. A real risk of loss
A year ago, holders of 13.375% Bristol & West PIBS got a nasty shock, courtesy of the Irish government. After B&W was taken over by the Bank of Ireland in April 1996, these PIBS became Bank of Ireland 13.375% Subordinated Bonds.
Instead of redeeming these bonds at their full value, known as 'par', the Bank of Ireland last June offered to repay them at just 20p in the pound, or a fifth of their value. However, on 28 June 2011, the Irish government backed down from this threat to give bondholders an 80% 'haircut'. Following a strong recovery, these bonds now trade at 87p, down just over 13% from their 100.34p issue price.
5. Slashed incomes
Two years ago, owners of 6.15% PIBS issued by the West Bromwich BS were furious when the West Brom reneged on its promise to pay by cutting this bond's coupon (income payment). As a result, the interest rate plunged from 6.15% a year to just 1.5% today. Thanks to this near-76% reduction in income, these bonds now trade at just 19p in the pound, a loss of 81%.
Similarly, in July 2011, Wales-based Principality BS cut the coupon on its 5.375% PIBS to a variable rate, currently worth just 2.66% a year. Following this coupon cut, these bonds now trade at 75p in the pound, down a quarter (25%).
In summary, PIBS are not savings accounts -- far from it. In fact, they are best described as a hybrid security -- a kind of halfway house between bonds and shares. Hence, although PIBS offer attractive interest rates ranging from 7% to 12% a year, they are simply too risky for risk-averse savers.
Should you buy Nationwide's new CCDSs?
It remains to be seen how much fresh capital Nationwide BS intends to raise from its new issue of PIBS-like CCDSs. However, I suspect that the society will aim to bring in tens of millions of pounds from this new investment.
What's more, I believe that Nationwide BS will have to offer a high coupon rate to make these CCDSs attractive to income-seeking investors. At present, its PIBS yield from 7% to 8% a year, but their CCDS replacements could offer lower yields, perhaps below 6.5% a year.
I wouldn’t recommend these securities to anyone but well-off investors with solid experience of investing in fixed-interest bonds!