Preference Shares – What investors should know

What prompted me to write this piece was the news report on DBS Bank’s third quarter financial results published on Friday in the Business Times.

The journalist quoted DBS’ chief executive as saying that “all of this quantitative easing and loose monetary policy (by the US) … will keep interest rates subdued.” We are not about to see a rise in interest rates for bank deposits any time soon. POSB deposit rate for first $100,000 is only 0.1 per cent.

For investors finding ways to earn better returns on their savings, DBS said that they would launch the retail tranche of preference shares before the year-end. When DBS issued $1.7 billion preference shares to private banking clients last month with dividend rate of 4.7 per cent and minimum size in investment of $250,000, the retail investors were left out of the action. This time round, the planned new preference shares will be of a lower minimum size in order for retail investors’ participation.

In the news report, the journalist ended by saying that there are some risks in preference shares unlike savings placed with bank.

What are preference shares?

Under the Companies Act (Chapter 50) Section 75, company can issue preference shares so long  “there are set out in its memorandum or articles the rights of the holders of those shares with respect to repayment of capital, participation in surplus assets and profits, cumulative or non-cumulative dividends, voting and priority of payment of capital and dividend in relation to other shares or other classes of preference shares.”

Preference shares are not ordinary shares and typically do not have voting rights at company’s annual general meeting. For this reason, they have preference over ordinary shareholders with regard to payment of dividends and repayment of capital. However, preference shareholders’ rights over capital repayment will rank below those of bonds/debt instruments issued by the company. In other words, the bondholders will be paid first before preference shareholders should the company is liquidated.

Before one invests in preference shares, one must study the terms of the issue. Some preference shares can be converted to ordinary shares in the future, known as convertible preference shares. Some preference shares are cumulative preference shares, meaning that dividends unpaid for some reasons are accumulated for future payment.

To see examples of preference shares issued, OCBC Bank has five listed on the Singapore Exchange (SGX), each with different dividend rate. Even when OCBC’s preference shares are traded on the SGX, volume of trade can be low or none at all. As an illustration, only one (OCBC Bk 4.2% NCPS) had trading volume of 70,000 on last Thursday. The other four had only 1,000 to 2,000 or none traded. So liquidity of preference shares traded is low and is a problem. Preference shareholders may not be able to sell off their shares at a better price if they needed money urgently.

The other risk of owning preference share is that holders may not get any money back should a company is liquidated since company’s creditors and bond holders get repaid first before preference shareholders.

Copyright © 2010, limkimtong for Living Investment

The material presented is intended to be general and written in layman’s language as much as it is possible. The author shall not be liable for any direct or consequential loss arising from any use of material written. Please seek professional advice from your financial advisor or financial institutions on material written covering financial matters.

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