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by Michelle McGagh on May 03, 2013 at 07:55

The Halifax 9 3/8% perpetual subordinated bond is one of the most popular stocks in our weekly Pibs and perpetual bonds table. At its latest price of 122.5p it provides a gross (pre-tax) yield, or interest rate, of 7.65% at a modest minimum investment of just over £1,200.

This bond – one of four from Halifax in the table – is what is known as a ‘conversion’ as it was converted from a permanent income-bearing share (Pibs) to a perpetual bond when the Halifax building society demutualised and listed on the Stock Exchange in 1997.

There are two main differences between Pibs and perpetuals. As with most bonds, Pibs have a maturity date when the company behind the Pib will repay investors the principal or ‘par’ value at which the Pib was issued, normally 100p. They also have a ‘call’ date when the issuer has the right, but not the obligation, to buy back the Pib at its par value.

Perpetual bonds do not have maturity or call dates. They go on forever or until the issuer decides to redeem the bond. The significance of this is that investors can only get their money back by selling the bond on the market through a stockbroker. The price they get will depend on market conditions.

Rik Edwards, Pibs and perpetual bond specialist at Cannacord Genuity, a stockbroker, said the main concern for the bond is inflation and interest rate rises. All bonds are extremely sensitive to changes in the cost of living and borrowing. This is because rising inflation will erode the spending power of the bond’s fixed interest payments. Similarly, rising interest rates will make the bond’s fixed interest rate look less attractive and its price will fall.

It is important to note that bond prices will often anticipate the change in interest rates and their price may fall before interest rates actually rise. Given that we have had four years of historically low interest rates it is inevitable that they will rise at some point. However, most forecasters say it is highly unlikely interest rates will rise before the next general election in 2015.

Edwards said: ‘Inflation and interest rates would affect the bond but with a gross yield over 7% there is a large cushion before you will get hurt.’

The advantage of perpetual bonds is they are ‘cumulative’ which means that if the issuer misses an interest, or coupon, payment, it has to pay up at a later date. With Pibs a missed payment does not have to be repaid.

Edwards said: ‘[The bond] is cumulative so if it does not pay on a particular year [Halifax] has the liability to make up the arrears. If it was a pure Pibs…and they cannot pay the coupon that interest payment is lost forever.’

This is an important point in light of the banking crisis of 2008. After its demutualisation the Halifax merged with the Bank of Scotland to form HBOS, a mortgage bank that went on a reckless lending spree that left it on the verge of insolvency.

The government had to ask Lloyds TSB to rescue the bank but ended up bailing out Lloyds in 2009 as bad debts mounted and public confidence in its position faded.

As a consequence of its partial nationalisation Lloyds was ordered not to pay interest to the Halifax bondholders for two years although investors in this bond later received the interest.

The price of bonds is linked to the creditworthiness of the issuer. Moody’s, one of three leading credit ratings agencies, has put Halifax plc’s long-term credit rating at Baa3. This is its lowest ‘investment grade’ rating, just above ‘speculative’, riskier ratings. However, the rating is not under review and Moody’s says the outlook is stable. This is against a backdrop of Lloyds Banking Group making a slow recovery from the crisis. In the first quarter of this year it made pre-tax profits of over £2 billion, up from £280 million a year before.

For more information read: ‘Q&A: what are Pibs and perpetual bonds?’