As an example of some of things you should consider when you wish to invest in preference shares, I will be giving a summary of one of the preference shares that OCBC has issued in July 2008 and that is the OCBC Class B 5.1% Non-Convertible Non-Cumulative Preference Shares.
This preference share is currently trading in SGX under the symbol, OCBC Bk NCPS 5.1% 100. The trading symbol itself can reveal a lot of details. OCBC Bk simply stands for OCBC Bank while NCPS stands for non-cumulative and non-convertible preference shares. As mentioned in my earlier article on preference shares, non-cumulative means the dividends that were not declared and not paid in the previous financial year will not be accumulated to the next financial year while non-convertible means there is no option for the preference shareholders to convert their preference shares to ordinary shares. The 100 at the end of the trading symbol means that the lot size is 100 shares i.e. 1 lot is equal to 100 shares as compared to the usual lot size of 1 lot is equal to 1000 shares.
I have attached the brochure for the preference shares and a snapshot of the summary of the details for this preference shares.
The following are some of the issues that you should consider.
1. Perpetuity
One of the main issue for preference shares is that it will never mature unless the issuer which in this case, OCBC Bank decides to redeem it back. Notice that it is stated very clearly that OCBC Bank may, at its option, redeem in whole but not in part the preference shares on 29 July 2013 or on each dividend date after 29 July 2013. As compared to bonds, the issuer has the obligation to redeem it back. So what happens if you wish to cash your preference shares out after holding it for quite a long time ? Either you can wait for OCBC Bank to redeem it back or try to sell it on SGX but that brings me to my second issue,
2. Liquidity
Due to the small quantity of preference shares that are issued generally, preference shares usually have poor liquidity and that pose a problem. Firstly, there may not be buyers who wish to buy your preference shares if you need to sell it and even if there are buyers, their buying price may not be that favorable i.e. the spread which is the difference between the buying and selling price can be rather far apart. That will definitely put you at a disadvantage.
3. Dividends
Do take a closer look on how much dividends they are issuing and whether it will remain the same. For the OCBC Bk NCPS 5.1% 100, it is clearly stated that the dividend is 5.1%. However, another preference share that was also issued by OCBC Bank in August 2008 i.e. OCBCCap 5.1% NCPS 100 has a different dividend policy. The dividend policy is such that on or before 20 September 2018, the dividend is 5.1%. However, after this date, the dividend is pegged to the 3-Month Singapore Swap Offer Rate plus 2.5% and that to me is a big difference. That would mean that the amount of dividends will fluctuate subsequently.
To conclude, do take note of the above issues that I mentioned if you wish to invest in preference shares. The best thing one can do is to read the prospectus thoroughly and understand what you are investing in.
Posts
Hi Kay
ReplyDeleteMay I check whether is there any difference in the default risk for the two OCBC preference shares. Can OCBC stop paying the dividend in any one year since it is not cumulative. Is it a good opportunity to buy now since it is trading below par now. I noticed UOB preference shares usually trade higher than OCBC preference shares despite the fact that it offers 5%, why?
regards
aaw
Hi aww,
ReplyDeleteIt depends on how you define default risk. In the broadest sense, OCBC preference shares will default if OCBC collapses as a bank.
It is possible for OCBC to stop paying dividends on its preference shares but that would mean that they cannot pay dividends for the ordinary shares too and this is very unlikely since OCBC has been paying dividends on its ordinary shares for the past few decades.
In my opinion, trading below par does not always means that it is a good opportunity to buy. As compared to bonds, if you buy bonds below par, you are assured of some capital gain when the bond is redeemed at par value at maturity. However, preference shares are perpetual and they do not mature. On the other hand, it's true that the price of preference shares have dropped to certain extent and the dividend yield is attractive indeed.
I have not looked at both UOB and OCBC preference shares in detail so I'm not really sure of the reason on why UOB preference shares is trading higher than OCBC preference shares.
Kay
Hi Kay,
ReplyDeleteThank you for setting up this wonderful blog. I have been reading your articles for a few months and I have learnt lots from it.
I have a question regarding 2 of OCBC's prefernce share. What is the difference between OCBC BK 5.1 NCPS (a.k.a class B prefernce share) and OCBCCap 5.1 NCPS?
Since both pays 5.1% dividend to their holders, why are stock prices for both so drastically different? The latter is currently trading at $95.98 and the former, $98.5. The difference adds up close to $3.5!
BullorBear
This comment has been removed by the author.
ReplyDeleteHi BullorBear,
ReplyDeleteThe OCBC Cap 5.1% NCPS pays a dividend of 5.1% per annum on or before 20 September 2018 and thereafter, pays a dividend based on the 3-Month Singapore Swap Offer Rate plus 2.5% while the OCBC BK 5.1% NCPS pays a fixed 5.1% perpetually. As such, the market may be pricing these two preference shares differently due to this reason so maybe that is why both preference shares are selling at different prices.
Kay
Hi Kay,
ReplyDeleteThanks for the prompt repy and the information!
Looking forward to more up-coming posts you have.
BullnBear
Hi BullnBear,
ReplyDeleteThanks for your compliment. I'm glad to be of some help.
Kay
Hi Kay,
ReplyDeleteYou mentioned that OCBC Cap 5.1% NCPS pays a dividend based on the 3-Month Singapore Swap Offer Rate plus 2.5% after 20 September 2018. So, if the "3-Month Singapore Swap Offer Rate" is 3%, then the dividend will be 5.5% isn't it? If so, unless ocbc decided not to pay dividend to the ordinary shares holders, for OCBC Cap 5.1% NCPS holders they will get at least 2.5%. Am I right?
by the way, what is "3-Month Singapore Swap Offer Rate"?
ReplyDeleteThank you.
Hi hwtan,
ReplyDeleteYes, the dividends will be 5.5% based on $100. However, the dividend yield that you will be getting may not be 5.5% since the yield will depend on your buying price of the preference shares. If OCBC decides not to pay dividends to its ordinary shareholders, preference shareholders may still get dividends since they are ranked higher. In other words, OCBC must pay its preference shareholders in full first before it can pay its ordinary shareholders. There is no fixed rule regarding this. SOR stands for swap offer rate and it is the average cost of funds used for commercial lending by banks here.
Kay
What preference shares means that holders of the preference shares will have higher priority to (i) dividends and (ii) liquidation proceeds as compared to ordinary shareholders, but subordinate to bondholders.
ReplyDeleteUnder normal circumstances, OCBC cannot pay ordinary dividends unless they have paid preference shareholders 5.1% dividends on their principal. However, that does not stop OCBC from paying dividends altogether (to both ordinary and preference shareholders). In addition, if preference shareholders will not be beneficiary to any dividend increases to ordinary dividends, hence will unlikely benefit from price increases in OCBC ordinary stock.
If OCBC was to go into liquidation, the creditors (bondholders, etc.) will get their money back first, followed by preference shareholders, and the common shareholders will get the remaining. Given that in most corporate belly-ups, debt holders typically get only 20 cents back on $1 of principal, shareholders (preference + ordinary) typically get nothing, so this is a moot point.
Hi Anonymous,
ReplyDeleteThanks for sharing all these information. I'm pretty curious on on the fact that you stated that debt holders typically get only 20 cents back on $1 of principal while the shareholders typically get nothing. Can you provide any links on this ?
Kay
I have subscribed to both the OCBC 5.1% NCPS and OCBC Cap 5.1% NCPS when they were issued at par and I have some 4.5% and 4.2% NCPS as well. During the the financial crisis, all of them go below par with the 5.1% NCPS hovering @0.93 and the 4.5%/4.2% @.83 respectively. I sold partially my 5.1% NCPS to buy in more 4.x% NCPS because the pricing is just ridiculus since 0.5% interest rate with more than a gap of 10% in value [20 years to close the gap]. All my NCPS are now above par. This means that I made 10% on the conversion and the 4.2% NCPS gains another 20% in value [$0.82 to $1.00 par.] Since I get 4/5% dividends as well. I consider this is one of the best and safe investment.
ReplyDeleteHi,
ReplyDeleteI think you made a very smart move in taking advantage of the pricing inefficiency in the market. That must have been very rewarding.
Kay
is occ ncps dividen tax exempt? thanks.
ReplyDeleteHello Kay,
ReplyDeleteThanks for your detail explanation on preference share and I hope you can help answer my questions. I am looking at 3 preference shares with today's closing price:
OCBCBank5.1%NCPS100 - 105.12
OCBCBank4.5%NCPS100 - 103.23
After normalizing the closing prices, the 5.1%NCPS share gives 4.85% PA and the 4.5%NCPS gives 4.35% PA.
My question is why would an investor hold the 4.5%NCPS? I assume the risk is more or less the same.
Thanks.