Friday, October 24, 2014

Looking at some Preference Shares

Hi guys, the markets have been feeling increasingly boring to me. It's just a mind-numbing grinding process that is moving entirely based on the news of what central banks are doing. Throw that book on fundamental analysis out of the window. Companies with crappy balance sheets have been massively outperforming well-capitalized businesses in the US the whole of the current market cycle. Pick up the book once we are well into the bear market and then make a watch list for pieces to dust off and pick up.

While I just sit on my hands and wait for opportunities, I decided to go and look at something which I've always been intrigued by, preference shares. Here is my "cheat sheet". Don't count on all the info to be correct, it's just rough info that I extracted for myself.


There are actually 7 preference shares listed on the SGX, but I have removed UE because they basically have no liquidity at all.

I have split the list into 2, the banks and the rest.

City Dev is a bit interesting because it is perpetual until it is called in for conversion. There are some more info about the conversion, but from what I read somewhere, this is probably never going to happen. But hey, who knows.

Hyflux is another interesting one because it gives the highest coupon payment of all the preference shares, at a nice fat 6%. After 2018 if it doesn't get called back in, coupons will bump up to 8%. I would guess that they redeem these shares.

The banks are a different interesting class by themselves. I don't know about you, but I personally see these guys as amazing stalwarts. I actually see them as the "risk-free rate", and on average it is about 4%. Let's be quite frank. If either of these banks are in trouble, the whole of Singapore is probably in shit!

DBS 4.7% and OCBC 4.2% actually gives 4.4% and 4.0% respectively. OCBC 4.2% is actually callable any time now, but it hasn't been called yet. I reckon that they are unable to get a lower cost of borrowing from the market, so they are content paying out a 4.2% coupon. DBS is callable from 2020 onwards. I reckon the reason why it is trading at a higher yield is because people suspect that it is more likely to be redeemed at maturity since it has a higher coupon. Totally zero basis for my speculation though, I'm just working through my own logic now. The good thing about these 2 preference shares are that their coupons after maturity date does not change, they continue to pay out the same coupon until redeemed.

OCC 3.93% and OCC 5.1% are different because they will have their coupons adjusted after they have passed the maturity date. They will be adjusted to the 3months SOR + 1.85% or 2.5%. Guess what is the SOR at now? 0.24%. So, after maturity, they will yield about 2.1% and 2.74% respectively. Which of course gives you a super measly return of just over 2% if bought at current prices. However, the good news is that they will probably never call back these guys ever since the coupons are so low! Maybe someone might want to correct me if my logic is wrong.

Personally, if I were to invest in preference shares, I would invest in the current fixed DBS 4.7% or the OCBC 4.2%. I would be getting 4% forever until they decide to call back these shares and then I get back the face value. And then I figure out where I want to park my money. I think this is about as risk-free as you can get without paying excessive premiums to the Singapore government to hedge away default risk.

However, if you're the kind that is really looking for the rock bottom "risk-free rate", I think that the OCC 3.93% and 5.1% offer a good rock-bottom place to look at. However, they may never get called back, meaning you would have to sell them back on the market. They would probably be trading less than face value to boost up their actual yield since their coupons are so low. This might means capital losses, unless rates are extremely low. I would imagine that only investors that are looking for certain recurring cashflows may find them interesting.

With that said, to me the "risk-free rate" is 4% when you look at preference shares. However if you are more concerned about the hierarchy of claims and want to be higher up as a creditor instead, looking at bonds you would probably get paid about 3% for an investment grade bond over 7 years. I wrote about corporate bonds a while back ago. Personally, I will gladly assume the risk of the company going belly up if that means I will get an extra 1% of yield. Perhaps others may not have that much of a risk appetite, but really, what are the odds of DBS or OCBC being driven into the ground?

4 comments:

  1. Got Money Got Honey,

    OMG! You really know how to spend your time well while waiting for an opportunity to present itself ;)

    I guess you know by now the knowledge we gain by actually owning some preference shares can be greater than all the paper research we do ;)

    To answer your previous question, yes. I've been "lucky" with currency futures. I'm more a macro guy; and currencies I've found are great vehicles to express such macro views.

    I am happy you are exploring different asset classes and investment/trading vehicles.

    Sincerely wish you get your fingers cut and burnt in your young age. (How's that for SMOL style cheerleading?)

    Then when your capital grows as you mature, you will naturally gravitates towards that vehicle that suits your temperament and interests ;)

    Good good.

    You are definitely not a man of one book.

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    1. Hi SMOL,

      Yes, I find the market a bit grinding and boring in the recent 1-2 months... Do you feel it too? Or is it about the same as always?

      Haha, I have yet to venture into these preference shares myself yet though. Maybe if I have a nice windfall I can consider some... Preference shares do have very limited capital appreciation though, which shares can provide. It seems like the typical stock-bond trade-off to me.

      Thanks SMOL, I also rather learn young and make mistakes when my portfolio is still baby sized. A 20% loss now is much easier to stomach in absolute terms compared to a 20% loss on a much bigger portfolio in the future. Still best to learn from others mistakes (free lesson!), but sometimes unavoidable to make your own, so must pay the price for it!

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  2. Hi GMGH,

    Your analysis is pretty spot on. I did a quick analysis some time back and if not for the OCBC 360 account, I would probably have put in some of my moolah into DBS 4.7%. In my humble opinion, these preference shares work like bonds, just that the coupons are much higher than what our government provides. =)

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    Replies
    1. Hi Mr 15HWW,

      Thanks! Yes, the high interest from OCBC 360 is quite compelling given that cash is so liquid and flexible! If the bonus interest rates drops (which I suspect they will soon), I might have to evaluate my options then.

      I also view preference shares very similar to bonds with regards to its income generation. However, unlike investment grade bonds, their market value do not hold up as well in a recession. Looking back at the OCBC 4.7% historical chart, the preference shares were abandoned quite badly during the GFC, so it cannot serve an additional source of liquidation to add funds to any "war chest" you might have.

      OCBC 4.7% Chart

      So I suppose, superior to IG bonds in income generation, but inferior in liquidation value during a crisis.

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