Permanent interest bearing shares (PIBS) are unique financial instruments that combine characteristics of both shares and bonds. This guide aims to clarify what PIBS are, their distinct features, how they function, and offers relatable examples to aid learners’ comprehension.
What are Permanent Interest Bearing Shares?
Permanent interest bearing shares (PIBS) are a type of security issued primarily by building societies in the United Kingdom. They are hybrid instruments that possess qualities of both shares and bonds. PIBS are often issued to raise capital and are typically redeemable at the issuer’s discretion, but they pay fixed or floating interest rates like bonds.
Key Characteristics of Permanent Interest Bearing Shares
- Hybrid Nature: PIBS combine features of shares and bonds, offering investors both equity-like and debt-like characteristics.
- Fixed or Floating Interest: PIBS pay fixed or floating interest rates, providing investors with regular income payments.
- Subordinated Position: In the event of liquidation, PIBS holders rank below other creditors but above ordinary shareholders, making them subordinated debt instruments.
- Redeemable or Irredeemable: PIBS may be redeemable at the issuer’s discretion, allowing them to be repurchased at predetermined dates or held indefinitely.
How Permanent Interest Bearing Shares Work
The mechanics of PIBS involve the following:
- Issuance: Building societies issue PIBS to raise capital for various purposes, such as funding expansion or meeting regulatory requirements.
- Interest Payments: PIBS pay fixed or floating interest payments to investors at regular intervals, similar to bond coupons.
- Redemption: Depending on the terms of the PIBS, they may be redeemable at certain dates or held indefinitely until the issuer decides to redeem them.
- Subordinated Status: In the event of insolvency, PIBS holders have a lower priority for repayment compared to other creditors but rank above ordinary shareholders.
Example of Permanent Interest Bearing Shares
Consider the following example to illustrate PIBS:
- Building Society XYZ issues PIBS with a face value of £1,000 each and a fixed interest rate of 5%.
- Investors purchase these PIBS, providing Building Society XYZ with capital.
- Building Society XYZ makes annual interest payments of £50 (£1,000 principal × 5% interest rate) to PIBS holders.
- The PIBS may be redeemable after a certain period, such as ten years, at the discretion of Building Society XYZ.
Real-World Application of Permanent Interest Bearing Shares
PIBS are commonly used by building societies in the UK to raise capital and manage their funding needs. They offer several benefits:
- Capital Raising: PIBS provide building societies with a source of long-term capital to support their lending activities and business operations.
- Income Generation: PIBS offer investors a regular income stream through fixed or floating interest payments, making them attractive for income-oriented investors.
- Risk Management: PIBS allow building societies to manage their capital structure by combining equity-like and debt-like characteristics in a single instrument.
Significance of Permanent Interest Bearing Shares
Understanding PIBS is essential for investors and financial professionals due to the following reasons:
- Diversification: PIBS offer investors a unique asset class that combines features of both equities and bonds, enhancing portfolio diversification.
- Income Generation: PIBS provide investors with a steady income stream through regular interest payments, particularly in environments with low interest rates.
- Risk Consideration: Investors should carefully evaluate the risk profile of PIBS, considering factors such as credit risk, interest rate risk, and liquidity risk before investing.
Risks and Considerations
While PIBS offer benefits, investors should be aware of potential risks:
- Credit Risk: PIBS holders face the risk of default if the issuing building society becomes insolvent or unable to meet its financial obligations.
- Interest Rate Risk: PIBS prices may fluctuate in response to changes in interest rates, impacting their market value.
- Liquidity Risk: PIBS may have limited liquidity, making it challenging for investors to sell them in the secondary market, especially during periods of market stress.
Conclusion
In conclusion, permanent interest bearing shares (PIBS) are hybrid financial instruments that blend characteristics of shares and bonds. They offer investors a unique opportunity to earn fixed or floating interest payments while benefiting from subordinated debt status. By understanding the features, mechanics, and risks associated with PIBS, investors can make informed decisions and effectively manage their investment portfolios.