OCBC has recently announced it is offering its Class B preference shares to its retail and institutional investors that pays a fixed dividend of 5.1% per annum. These preferred shares are non-convertible and non-cumulative and the fixed dividends are tax-exempt, payable semi-annually.
For the retail investor, the minimum subscription is 200 prefernce shares of S$20,000 and thereafter in multiples of 100 preference shares for $10,000. These shares are perpetual securities with no fixed redemption date, redeemable at the option of OCBC Bank five years from the issue date and on each dividend date thereafter. It carries an investment grade rating of A-/Aa3.
Things you should know before you invest:
* Non-convertible preference shares
This means the preferred shares are not convertible to equity. While this might be preferred by some (preference shares rank above equity in liquidation), it essentially treats this like a fixed-income security, but not a loan. A loan debt is like you lent $20,000 to OCBC and it pays you 5.1% p.a. in interest. However, capital is NOT guaranteed, so it should be compared to a fixed-income security such as a coupon bond.
* Non-cumulative preference shares
There are cumulative and non-cumulative preference shares available. Non-cumulative shares means if OCBC faces cash flow problems and decides not to declare dividends, these preference shareholders forfeit their dividends, i.e. no dividends for the year. This is another feature that makes it different from a plain-vanilla loan. However, one consolation is OCBC has to pay preference shareholders before their equity shareholders, and in previous years, OCBC has been regularly paying its shareholders. So the likelihood of this is small, although not zero.
* No capital guarantee
As mentioned, this is not a loan or fixed deposit (as many retail investors choose to see it). This cuts both ways because it also allows for capital appreciation as well. A look at OCBC's Class E 4.5% preference shares shows that prices are relatively stable and it is currently trading at 100.70.
Also, note that should OCBC run into bankruptcy, preferred shareholders are paid before common equity shareholders, but after taxes, employees and debtors.
* Liquidity
Shares are traded on SGX at 0.1 lots. For large lots, market impact costs might be incurred. It is possible that only 10 lots or 10,000 shares are traded daily. This makes it difficult to sell if you should need money urgently.
* Interest Rate Risk
These shares are redeemable after 5 years on each dividend date. The option to redeem lies with the bank; usually the bank will redeem if the current interest rate environment is falling or the level of interest rates is low so they could refinance at a lower rate. For the preferred shareholder, this means that they have to seek alternative investments as they have a lump sum of cash on hand upon redemption by OCBC. However interest rates are low and they might not be able to get good yields on the cash balances and are subject to the prevailing SIBOR rates.
* No voting rights
Voting rights are given to common equity shareholders. Preferred shareholders typically have no say in the business of the company and are not in a position to fire management/directors. This is another reason why preferred shares are likened to fixed income securities.
* Tax-exempt
The semi-annual dividends, like most other dividends and interest income, are not taxed. Dividend income received by common equity shareholders are already taxed at the company level.
Should I invest?
* Risk appetite
This varies from individual to individual. It depends largely on your risk appetite - if your risk appetite is low and you are risk averse, yet would like some exposure to OCBC, this could be a right investment for you. However, if you have medium to large risk appetites, you might want to choose OCBC equity because you have participation rights, i.e. in a good year, you might receive special dividends and could thus get >5.1% p.a. Also, OCBC equity are more liquid and more volatile than preference shares so capital appreciation (and loss) is much faster. On average, equities return ~10% p.a. over a ten-year period.
* Investment Horizon
If you need the money in a year's time, then you should not invest. You get 5.1% in dividends but after incurring transaction costs and opportunity costs, it is less than 5.1%. Thus, this is best for three-five year term horizon and beyond.
* Your existing portfolio
If you have cash lying idle in bank deposits, then yes you should consider this higher-yielding alternative. This is a higher rate than most fixed deposits and inter-bank rates (since the risk characteristics are different). However, if ALL you have is $20,000 to $40,000 I would advise against choosing this. You should have six months of expenses in liquid bank accounts for emergency funds use. And you should attempt to diversify whatever little you have instead of throwing all your net worth (your eggs) into OCBC preference shares (the only basket).
* Current status
If you are currently a retiree looking for stable income, this is a good addition to your portfolio. However, if you are in your early 20-30s, this can be part of your portfolio to diversify (it works like fixed income) if your portfolio or net worth is large enough. Otherwise, choose other (riskier) investment alternatives.
My thoughts
I applaud OCBC for providing retail investors with this option to invest in their Class B preference shares. They did take our feedback into account especially after DBS only offered their Tier 1 capital to institutional investors.
I might consider applying for the shares but I expect it to be over-subscribed. However I'm ambivalent about whether or not I receive the allotment since my existing equity portfolio has provided me with 9% return to date (7% trading gains + 2% dividend yields which I will update on another post) and my funds are still trading at a 10% unrealized loss. I am hesitant about liquidating my equities to invest in OCBC preference shares, or even my externally-managed funds as I hold a three to five-year horizon for them so I am holding on. Given the relative size of 1 lot of OCBC preference shares and its relative return, it is not attractive in my opinion.
NOTE: Please seek your financial advisor's advice about investing in these preference shares. I have brought up a few salient points for you to take note so you are aware of the questions to ask and you could decide if this is the best investment for you.
For more information on OCBC's previously-issued classes of preference shares, visit this website http://www.ocbc.com/global/investorrelations/Gco_Inv_PrefShareBond.shtm.
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