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Bond of the Week: 15 May 2012

We take a look at the old Kent Reliance Building Societies PIBS, now liabilities of the new One Savings Bank......... 

    

Most investors are familiar with the structure of UK building societies. Such institutions are “mutuals”, owned by the borrowers and savers that make up the customer base. In theory, that helps the building societies, who have no shareholders to pay, to provide a better service for their users.

That’s the plan, although competition in the market combined with the greater economies of the big banks means that there is often relatively little difference in the cost of mortgages or savings rates.
 
Whilst the mutual structure has some clear advantages, there is one area where it has a drawback; with no shareholders to call upon, it is hard for the building societies to raise capital.
 
A couple of years ago, the mid-sized Kent Reliance Building Society found itself in need of such capital and decided to take an unusual move. After consultation with its members, the society transferred its entire book of savings and loans to a new entity, One Savings Bank. This new bank was to be 40% owned by a division of JC Flowers (the US private equity fund), who in return injected GBP50 million into the new bank. A second “top up” GBP15 million was paid in August of last year. More detail is available on the company’s website here.
 
Kent Reliance’s PIBS, along with the rest of the balance sheet, were transferred to the new entity, where they have become subordinated liabilities of One Savings Bank.  There are two issues outstanding, which I have shown with the indicated current offer price and the corresponding running yield. 
  • GBP22 million One Savings Bank 6.591% perpetual subordinated bonds (1SBA), callable 2016. If not called, the coupon resets to gilts + 3.4%. Trading at 72 in the market (offer side), the running yield is 9.2%.
  • GBP15 million One Savings Bank 7.875% perpetual subordinated bonds (1SBB), callable 2014. If not called, the coupon resets to gilts + 4%. Trading at 66 in the market, the running yield is 11.9%
Both issues are relatively small in size and have a fairly thin market. However, private investors are active in these securities, which can be traded by the majority of brokers. 
 
My view: My first thought is that private equity and a building society make for slightly odd bedfellows. Consider also that One Savings Bank still has some work to do before it returns to profitability. Results for 2011 showed a small loss of GBP11.1 million with the new bank stating that it will need to book higher-margin business in order to return to profitability. That should be possible in the current environment, but no doubt it will take time.  Added to that is the uncertainty over the call features and associated coupon resets for both these securities in just a few years time.
 
On balance, the bonds featured above make for an interesting recovery play for risk-positive investors, but should be treated with appropriate caution with the usual caveats on diversification. 

Mark Glowrey

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