Non Redeemable Preference Shares?

[Surena]

Hello. I bought some Non Redeemable Preference Shares from Lloyds a few days ago at about 97p, which was slightly different from the ordinary share price. The share has a 9.75% tag, I can't find any more details about it but I'm assuming that's the yearly dividend? Are they usually paid out on an annual basis or semi annual? Also, why are they slightly different in price from ordinary shares? I've seen the ordinary share price go up but the preference share price has actually gone down slightly? Thanks in advance!

[fathippy]

May I ask (without sounding rude) - why the hell did you buy these things with all these questions outstanding. I can understand someone saying "I am thinking of these, but I need to know the following" but to ask after having transacted is madness.

Preference shares are not shares at all, but a debt product of limited security. They are used to "fool" the regulators as to the state of the balance sheet as they count as equity capital even though they are not ie. if they were properly described they would add to the debt burden of the company.

The schedules for these are normally very long (250+ pages) and need reading quite closely as they vary between issue to issue and duration to duration. Also, it is quite common for the headline number to only cover a limited number of years (like the fixed rate part of a mortgage) and then they revert to some other function of LIBOR.

Basically you have paid 97p for something that will pay out 9.75p a year (probably half yearly, maybe quarterly) which is a 10% yield. At one stage at the height of the crisis there were lloyds instruments yielding 30% - bear in mind they are at the bottom of the pile when it comes to getting any money back in a disaster. I believe there are plenty of similar lloyds products at the moment in the 15-20% bracket. The yield will reflect the going rate of interest plus the credit spread for how risky the company, or the structure, or the product itself is. Trading or owning these things requires analysis of all four of these items.

Finally... and I have waffled for a bit here - the reason they move differently to ordinary shares is they do not participate in any of the upside. If the company got back to full health and was making huge profits, the shares could be £3 or £4, but it is unlikely the prefs would yield much less than 7-8% implying 120p and if interest rates rocketed to 6-7% the prefs could be happily yielding 10% even at a full bill of health.

[Surena]

Thanks that's what I figured. It's a medium-long term investment and I would rather get a high dividend than voting rights, which is what I understand preference shares to be. It's not a huge amount of money, but seeing as how the shares were about 94p at the time, I assumed it would be a good time to buy. It's also my understanding that preference shares are at the top of the pile when it comes to paying dividends so they are reasonably safe, especially given the recent rallies and Lloyds claim that their bad debts have peaked. Please correct me if I'm wrong. Thanks for the response!

[fathippy]

Granted they are ahead of ordinary shares in the payment of dividends, but given that the ordinaries are not able to pay a dividend whilst the government is involved, this makes no real implication as to the strength of the pref divi. It is also complicated how they may cross-covenant each other, as some are cumulative (ie you pay all the outstanding divis when payment restarts) and others are not. That would suggest, as the rules allow that they pay the cumulative dividends first, as they will rack up as a liability.

The one plus point to consider is that it is balance sheet efficient and to an extent tax efficient to buy these things back in the market if they get too cheap, so there is a natural base, but all things considered at 10% yield that is unlikely to happen.

[David Griffiths]

:redface:Have you checked the position on whether the dividends are actually being paid? If I understand things properly LTSB aren't allowed to pay dividends while they're borrowing government cash. Don't know if that applies to prefs, but they didn't pay an ordinary dividend last time.

Oops - Didn't see the hippy's post!

[Surena]

Ah, well at least it's a good opportunity to learn. Their dividend history for 2009 (can't post links) is empty but given articles like (can't post links), added to their recent rallies, and the general consensus that the system should stabilize by 2011-12 (which is how long I intend to hold them for), I'm hoping for a good return on the share price if not necessarily the dividend, which is far better than I expect to get with any other of the bank shares.

My decision to buy Lloyds was bolstered by reading in a Times blog that the RBS boss has been selling his share, even though he's getting a big bonus if he increases the price to 70p. The other banks that I know of have recovered much from their March lows, thus not being very appealing. So, holding this for 2-5 years on big returns on the share price alone possibly augmented by dividends, what are your thoughts?

[fathippy]

what are your thoughts?

In question and answer format......

I'm hoping for a good return on the share price if not necessarily the dividend, which is far better than I expect to get with any other of the bank shares.

I am not sure you fully understood what I said above. This is a bond in all but name so a "good return" is the last of your expectations. Granted, they can show growth if they have previously been of "junk" status, but this has mainly happened, since they were 50p in April and 75p as short as a few weeks ago. The reason you should hold them is for the income, if you are happy that this is covered and likely to happen. It is the ordinary shares that will show a "good return" in the event of an upward change in fortune.

The other banks that I know of have recovered much from their March lows, thus not being very appealing. So, holding this for 2-5 years on big returns on the share price alone possibly augmented by dividends

See above, I think everything has recovered massively over the last three months, so LLoyds is no different - they were sub 40p at one stage and are now at £1. Even their prefs which are boring credit products have doubled in most cases, so these must also fall into your category above "thus not being very appealing".

I hate to bang on about this, but you really need to understand the product you own. If you know nothing about bonds, or credit products in general I suggest reading up on them. For example, if all else remains equal, and the base rate / LIBOR rises back to where it was in 2008, these products must de-value without question. Luckily, there is a strong correllation between interest rate rises, and commercial strength, so the "all else remains equal" bit may not hold, but the point is you need to understand what this thing is and none of the above comments suggest anything of the sort.

[Surena]

Alright, there was a fundamental misunderstanding of the nature of preference shares on my part. I'm actually reading up on bonds right now, a book called Introduction to Bond Markets by J Patrick, but I bought the shares through HSBC InvestDirect and there was no additional information available when I bought this. If it really is a bond, I would assume that it would say if there's a call option, what the redemption date is if there is any, the redemption value, and so on. The absence of the above and any other relevant information gave me no reason to believe that the price of a preference share should move in any way different to a regular share. I'll try to get a book directly related to the stock market over the summer.

Although perhaps a naive move, I've learnt quite a bit so thanks for responding.

[fathippy]

Unfortunately there is no requirement for any security to openly advertise its pros and cons - that is the job of the investor to research and understand. You may have a case against the broker if they led you to believe it was something it wasnt, but most of these guys, even if they have nice leather chairs and sit down with you for hours on end, still hide behind the fact that they are "execution only" and hence are only doing what you ask them to.

Regarding all the small details you can find them here:

http://www.lloydsbankinggroup.com/investors/debt_investors/capital_issuance.asp

note the giveaway part of the address which is "debt investors"! click on the prospectus for the 9.75% and you will find a 232 page document outlining the details. In short the divi is half yearly in so much as the funds are available to pay, and in the event of liquidation the nominal value is £1.