Doyl Smith, Guest Writer
In this May 1, 2007, photo, Scotiabank Jamaica's financial officer and vice-president Stacie-Ann Wright, adds the Bank of Nova Scotia variable preference stock to the board of the Jamaica Stock Exchange. - File
Preference shares are gaining in popularity with three financial institutions having offered preference shares to potential investors, boosting those listings on the Jamaica Stock Exchange to 13 stocks issued by eight companies.
Other listed companies are either in the process or seriously considering putting out an offer.
The recent share issues have been snatched up by the investing public with significant oversubscription rates pointing to the strength of the demand in the market place.
The Mayberry 12 per cent raised more than $500 million in November - its initial target was $360 million - while NCB Capital Markets did a renounceable rights issue in May on its 11.75 per cent prefs that were originally issued September 2006.
Bank of Nova Scotia Jamaica (BNS) also created a bonus issue earlier this year as incentive to shareholders for buy-in to the restructuring of the group operations.
Jamaica Money Market Brokers plans to issue two prefs, while Pan Caribbean Financial Services has an offer under consideration.
With this in mind, let's take a look at exactly what are preference shares, along with the advantages and disadvantages of adding this asset type to your portfolio.
WHAT ARE PREF SHARES
The website About.com defines preference shares as being "a hybrid between common stock and a bond."
Prefs are usually issued by a company or corporation.
Each share of preferred stock is normally paid a guaranteed dividend which receives first priority - that is, the common stockholders cannot receive a dividend until the preferred dividend has been paid in full.
The preference shareholder also has a greater call on the issuing company's assets in the event of bankruptcy.
This means that a preference shareholder would have additional protection over an ordinary shareholder, including the advantage of receiving their coupon payments even if ordinary shareholders do not.
OWNERSHIP ADVANTAGES
The advantages of owning preference shares are many. Some of these are:
Tax-free status: Preference share coupon payments are treated as dividends and so they are tax free to the unit holder.
This means that if a preference share is paying, for example, 12 per cent per annum, an investor would have to find a taxable instrument paying in excess of 16 per cent (or 18 per cent for a company) before they would have similar 'in pocket' returns.
The comparative rate is, therefore, much higher than many other available instruments.
Consistent dividend payments: The investor can know at the outset what the annual returns will be on their investment - and, in some cases, the returns per month - as compared to the unknown return of holding ordinary stock units which may vary from year to year, depending on the movement of the stock's trading price.
Frequency of payments: Recently, preference shares have been coming out with interest payments as regularly as once per month.
This allows the investor to efficiently plan his or her cash flow needs and, if the cash will not be needed, to reinvest in an interest-bearing account and compound the returns.
Returns often exceed U.S. instruments: The Jamaican dollar's average annual depreciation has been roughly 4.0 per cent against the US dollar; but has topped 6.0 per cent in the current calendar year to date.
For the returns to the investor in USD-denominated instruments to exceed that of the preference stockholder - given the rate of return that several of the newer issues have been coming out at - the Jamaican dollar would have to depreciate by 9.0 per cent per year for all the years until the preference stock matures.
DISADVANTAGE
Because preference shares are fixed-rate securities with, in many cases, a pre-set maturity price, it will not move like ordinary stocks.
If, for example, a financial company were to discover a way to massively increase its profits, while the ordinary share price would likely go through the roof, the price of the preference shares would not see that gain since its returns are fixed.
It, therefore, might not be the asset type for investors looking for explosive gains.
EARLY EXITING
Once a preference share is listed on the stock exchange and there is demand on the market, just like any other investment type, it can be freely sold to another party or entity.
If interest rates are flat or declining, there may even be the potential for capital gains.
Preference shares are an excellent asset type for an investor that is looking for clarity, that is, knowing exactly what his or her returns will be at the end of the day.
The returns on preference shares are often significantly in excess of taxable instruments and the frequency of coupon payments will allow investors to plan their cash flow well in advance.
Preference shares provide strong, stable returns that will likely outpace devaluation.
Doyl Smith is a corporate relationship manager with JMMB. Email: doyl_smith@jmmb.com
