It's been an anxious few weeks for thousands of bondholders at the Co-operative Bank. The bank recently announced that, as part of its restructuring to plug a £1.5bn shortfall (dwarfed this week by Barclays' £12.8bn balance sheet hole), it would stop paying interest on a type of bond called a permanent interest-bearing share (Pibs) and that these bonds would be swapped for new bonds and shares. This, in turn, would mean a cut in their value. Those affected had originally bought these bonds from the Britannia building society before it merged with Co-op bank in 2009.
Pibs are designed to pay an income – often quite a high level of interest – and so were popular with older investors.
The Co-op bank bondholders won't know until later this year exactly what they will be offered, but in the meantime, an action group is campaigning for a better deal (and, it has to be said, is particularly critical of the new bank regulator, the PRA, for its role in forcing Co-op bank to plug its financial hole so quickly).
When is a bond not a bond?
When the news of the Co-op bank restructuring broke and it emerged that some bond holders could lose money, I received a steady steam of questions from people who wanted to know if their savings were at risk.
They had put money into fixed-rate or fixed-term savings accounts, which are often unhelpfully marketed by banks and building societies as "savings bonds".
And so we come to my (latest!) gripe. The word "bond" is variously – and casually – used in the financial services industry to mean a savings account, an investment and – its true meaning – an IOU for a loan to a company or government. Do they have anything in common? Not necessarily.
You and I know that the financial services industry is guilty of far greater sins than using incorrect or confusing terminology to describe a product, so it may not seem like a big deal. But it does little to help savers or investors make an informed choice about what they're going to put their money in.
Savings accounts or savings bonds?
Savings accounts that pay a fixed rate of interest or last for a fixed term aren't bonds in the true sense. They're just savings accounts.
That means the value of your capital (that is the amount you initially pay in) stays the same.
Any return you get comes from interest that your savings earn and, because they are savings accounts, money in them is protected by the Financial Services Compensation Scheme (FSCS).
In broad terms, the coverage is up to a limit of £85,000 per person per bank or building society.
It's actually a bit more complicated than that if banks and/or building societies are in the same group and share a single authorisation, when the £85,000 limit is shared, but the fact is that the FSCS safety net is there for savings in a UK-authorised bank or building society.
How are bonds protected?
Bonds (and I mean true bonds) aren't protected by the Financial Services Compensation Scheme.
That means if you invest in them and the company issuing the bonds goes bust, you don't have any automatic right to compensation. In fact, depending on the type of bond you own, you could get back very little at all.
Permanent interest-bearing shares are also not protected by the FSCS.
They're sold by building societies, but, if the building society demutualises (as happened to a number in the 1990s) or merges with a bank (as happened with Britannia), these Pibs could be converted to "subordinated" bonds.
And unlike senior bonds, which normally pay a lower rate of interest, subordinated bondholders will be at the back of the queue if a company goes bust and can lose out if it restructures.
Bonds are often thought of as relatively low-risk investments. Some of them can be, but they're certainly not risk-free and some can be very risky indeed.
Don't assume that something that has the word "bond" in the title is a) safe or b) a bond.
Find out what you're getting into before you part with your money.Reuse content