The following is a general description of preference share and permanent interest bearing share features.

What are Preference Shares?

Preference shares (prefs) are so called because they have preference over ordinary shares for payment of dividend or return of capital. However, they are junior to all forms of company debt, including debentures, loan notes and bank debt on a winding-up.

A company can be put into administration if it fails to pay interest on its debt, but preference dividends, like ordinary dividends, are paid at the discretion of directors. This means that preference shareholders have no recourse to the company in the event of non-payment, although the company will not be able to pay an ordinary dividend until preference dividends have been paid.

Generally prefs pay dividends twice annually. Most are undated, but some have a final redemption date. Most are cumulative: this means the company is obliged to pay any pref arrears from previous years before it can pay an ordinary dividend. There are also, however, some non-cumulative bank pref shares, which were issued by banks to boost their tier 1 capital bases. In the event of non-payment, shareholders would receive stock to the nominal value of the unpaid dividend.

Purchases of prefs, like equities, are subject to 0.5% stamp duty. The capital gains and income tax treatment is also the same as for equities. Prefs are dealt “dirty price” i.e. with accrued dividend in the dealing price, and not dealt separately as with bonds.

Broadly speaking, preference shares fall into three main categories:

• Leader prefs – large issues, relatively liquid stocks, generally banks and insurance companies.
• Higher coupon second line prefs – these tend to be difficult to trade. These can be a source of high yield opportunities for investors familiar with the issuing companies.
• Low coupon prefs – where stocks trade substantially below par, investors are often willing to buy them on lower yields than leader prefs, reflecting the chance of an attractive repayment at par.

What are Permanent Interest Bearing Shares?

Permanent Interest Bearing Shares (“PIBS”) are building society shares listed and traded on the London Stock Exchange. Generally they have a fixed coupon, and are irredeemable.

On a winding up, PIBS holders rank behind all other lenders, depositors and members holding share accounts, and any repayment would be limited to par, or 100p per share. Unpaid interest is non-cumulative: ie if the society fails to pay interest one year, it will not be required to pay any arrears in future.

Interest is paid gross semi-annually: an investor should then declare it in his tax return.

PIBS are dealt clean of interest: this means that the accrued interest is settled separately, as it is with bonds. No stamp duty is payable on UK issues.

PIBS holders are members of the issuing building society, and are entitled to one vote, regardless of the size of their holding. This has made PIBS attractive to carpet-baggers, who tend to buy the minimum dealing size in order to benefit from any takeover or conversion to plc.

Where a former building society has been taken over or converted to a plc, the PIBS have been converted to perpetual subordinated bonds, whose characteristics are similar to PIBS.

PIBS and subordinated bonds can only be dealt in round amounts, varying from 1,000 shares up to 50,000.