Friday, November 12, 2010

Preference shares - perpetual and redeemable

Dear Mr. Tan,
The DBS preference shares are perpetual (i.e. have no expiry date), but are callable (redeemable) by the bank in 2020. Does it mean that DBS will return the capital investment to the investors in 2020?


REPLY
The perpetual nature allows DBS to keep the money forever and to pay the dividend at the specified rate.If DBS is in trouble, they may not pay the dividend (you have to check on this point).If DBS goes bankrupt, you may lose all of the invested sum (but this risk is very small). A preference shareholder has a higher risk that a bond holder but lower risk than DBS sharehholders.

DBS has the option to redeem the preference shares in 2020 and pay back the shareholders. They will do so, if they find that the interest rate is low and they can refinance the preference shares at lower cost. However, if interest rate goes up high, they are likely to keep the preference shares beyond 2020.

The preference shareholder can sell the shares at any time through the stockmarket, at the prevailing market price. The price will increase above par, if the market interest rate has dropped. the price will decrease if the market interest rate increases.

I have asked a financial expert to make a brief analysis and post the details in the FISCA website (www.fisca.sg). It will be available to FISCA members after login.

3 comments:

Spur said...

This $500,000,000 exercise by DBS is actually a re-financing exercise. They are raising cash to redeem the 6% preference shares DBS sold in 2001, which they want to redeem next year 2011. See? Redeem the higher interest pref shares, and sell the lower interest ones now as interest rates are low low low.

Currently not a good time to buy such a long-dated fixed income instrument. Unless you're a retiree looking to live off interest income, and you're very confident you don't need to touch the principal sum.

Interest rates are about the lowest in history now. With money printing & devaluation, you can see inflation working into commodities and raw materials. Most likely interest rates will be much higher in 2020, making it unlikely for DBS to redeem it for a long time to come.

While you can always sell it on the open market, but usually such pref shares are quite illiquid and you need to suffer a large discount for others to buy. Furthermore, as explained above, interest rates likely to go higher from here, and the market price of your pref shares will go down. I.e. be prepared to suffer some capital loss if you buy this pref shares.

If you are just interested in the 4.7% payouts and not worried about 10%-15% capital loss, and you have other cash and investments to diversify your risk, then perhaps ok.

Unknown said...

i think both mr tan reply and the above dude have already explained all.

tan wa lau

Unknown said...

I expect strong demand. Many people unknowingly have been keeping their money for years in bank and getting poor interest. May as well invest in preference shares

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