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Bond of the Week: 2 September 2013

Nationwide Tender Offer.

    

Nationwide has issued a tender for 5 of their PIBs.


Institutional holders have until 9th September to reply and individuals have until 24th September.

The rationale appears to be both to re-organise their capital in light of the new Basle III regulations under which these PIBs will count as neither core Tier 1 (equity) nor even Tier 1 capital and in addition to give investors an opportunity to get out of their positions. From an institutional perspective it can be difficult to exit a large position (for instance of £500,000 or more) without suffering a discount to an already wide bid offer spread.

All the bonds/PIBS have call features with what at the time were considered step up features (given current low gilt yields, as of today in many cases these have become step downs). The unwritten understanding at the time of issue of these bonds, as with all other similar financial subordinated bonds, was that they would be called at the first opportunity. Until the arrival of the 2008 financial calamity, finding a bond that had not been called at its call date was as difficult as locating hens’ teeth. In the brave new financial world we now inhabit there has been a slow but inexorable move to issuers calling only if it is in their financial interest to do so. However, good quality well-known issuers, a group to which Nationwide would maintain it belongs, are anxious to keep their institutional investors on-side and a tender offer fulfils this purpose. Bond owners will have been offered a chance to get out and so will be unable to complain if the bond is not subsequently called. To that effect, Nationwide states in their tender offer “Future decisions with respect to capital calls will be made in light of the then prevailing market, economic and regulatory conditions.”
As part of their capital re-organisation Nationwide has mooted on a number of occasions that they will be issuing a new and regulatory acceptable form of capital instrument for building societies – Core Capital Deferred Shares (CCDS). To date no CCDS instrument has been issued but we can be sure they will have some poisonous (for bond holders) language in them. However with the poisonous language there is also a good chance of a good yield. The pity for retail investors is that they will almost certainly not be invited into that particular sweet shop (denominations are likely to be £50,000 if not £100,000) as no one wants to be accused of miss selling to them. Therefore for those who tender their bonds, an exit from holding Nationwide bonds may be a permanent one.

The yield to call and in perpetuity (using today’s rates) of the bonds are as follows:

I do not know why the 5.769% seems to have been treated favourably over the 6.25% in terms of yield at tendered price.

Holders should consider not only whether the yield to call is high enough to warrant keeping the PIBS but also decide whether the perpetual yield (not knowing what future interest rates might be) is high enough. Bear in mind the lower the fix the lower both the future yield of the un-called bond and the higher the probability that the bonds won’t be called. You should always remember that a call is an option they, not you, have and therefore will be used if it suits them when theoretically it will not suit you.

What to do? It all depends on what you consider is an acceptable yield for holding long dated subordinated debt. You need to take a view both on interest rates and what is an acceptable return for the credit. The lower the absolute yield of any bond the more an attempt at guessing future interest rates becomes a major factor in deciding whether to hold on. I would tend to view the yield at the tender price of these bonds as low so an interest rate calculation/ guess is important. You might say to yourself if I change my mind on rate in future I can always sell my holding in the market. My thinking, however, is that it is likely that the bid price on these PIBS will be below the tender prices offered for the foreseeable future.

The doyen of the PIB and preference share market, Rik Edwards, has said: “Unless investors are worried about the credit quality of Nationwide, there is no compelling reason to tender their stock, as they will find it difficult to replace the yield on these PIBS.” Doubtless because I am, as ever, greedy for yield, my view is slightly different. I suspect there is no compelling reason to keep them and in that case they should probably go. I expect most institutional holders will tender leaving only rump issues which will have wide bid offer spreads. I have no problem with holding rump issues (I have many) if the yield is right. By “right” I mean large enough not to mind if I never have the opportunity to sell the bond again. Yields around 7% do not, to my mind, reach this required level. I also think, to borrow a term from numismatists, that although Nationwide is a fine credit, it is not an extremely fine one. People may also have a warm feeling towards Nationwide as a champion of mutuals (although rather less warm following the Co-op debacle). That, I think, should not form part of any investment decision making. Therefore while I always have the greatest respect for Mr. Edward’s opinions, this time mine diverges and I say “let them have it”. 

Oliver Butt

Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income. The author and or the LLP may hold a position in or trade in any of the securities mentioned above.

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