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Preference shares -- keeping it simple

Gilts, bonds, and interest-bearing shares
PeterGray
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Re: Preference shares -- keeping it simple

#147108

Postby PeterGray » June 21st, 2018, 11:38 am

GoSeigen wrote:
PeterGray wrote:I think it's pretty clear, Stockton, that redemption and return of capital are distinct. I don't see much mileage in revisiting that yet again.
Peter


Unless this is a typo, I think PeterGray and Stockton are going to be arguing about something that is not fundamental.

The real point of contention is that "redemption" and "reduction of capital" are distinct processes. The Companies Acts are pretty clear that they are.
GS


Yes, a mistyping, than your for the correction - it should have been "reduction"

And no, I'm not going to be arguing with Stockton about it - there's nothing more to be said!

Peter

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Re: Preference shares -- keeping it simple

#147139

Postby Alaric » June 21st, 2018, 3:48 pm

GoSeigen wrote:However in announcing his intention in advance he practically guaranteed that the market price would rise to par anyway.


Had he not done so, the higher coupon issues in particular might have gone above par. The government is then in Aviva territory as to whether it had the right to make a compulsory repayment at par and whether it intended to exercise that right.

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Re: Preference shares -- keeping it simple

#147153

Postby ChrisNix » June 21st, 2018, 4:48 pm

Alaric wrote:
GoSeigen wrote:However in announcing his intention in advance he practically guaranteed that the market price would rise to par anyway.


Had he not done so, the higher coupon issues in particular might have gone above par. The government is then in Aviva territory as to whether it had the right to make a compulsory repayment at par and whether it intended to exercise that right.


Alaric,

Just finished a fairly turgid annual accounting session.

I may be demob happy, but your post made me consider the apparent circularity of some of the thinking.

The market ramps the pref price to a ludicrous level, given the cancellation rights, and then insists that unless holders get the market price the issuer is somehow acting improperly!

Contrast against a situation where the market properly weighs the cancellation rights and the prefs sell at say 120%. My guess in such a situation the issuers would feel the PR benefits of paying a sensible market price might be worth some premium.

As the Irishman might have said, if you looking for a premium I wouldn't start here.

Chris

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Re: Preference shares -- keeping it simple

#147156

Postby Alaric » June 21st, 2018, 5:01 pm

ChrisNix wrote:The market ramps the pref price to a ludicrous level, given the cancellation rights


It's poor drafting of the Articles, the Companies Act or whatever that appears to create the cancellation rights in the first place. If it was unambiguous that a vote of ONLY the Preference Shareholders was always required, cancellation at par would remain just a theoretical possibility with the Issuer's option to cancel having no practical value.

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Re: Preference shares -- keeping it simple

#147210

Postby ChrisNix » June 21st, 2018, 10:52 pm

Alaric wrote:
ChrisNix wrote:The market ramps the pref price to a ludicrous level, given the cancellation rights


It's poor drafting of the Articles, the Companies Act or whatever that appears to create the cancellation rights in the first place. If it was unambiguous that a vote of ONLY the Preference Shareholders was always required, cancellation at par would remain just a theoretical possibility with the Issuer's option to cancel having no practical value.


Alaric,

The cancellation rights are not down to poor drafting, they are 'traditional' for UK prefs. Furthermore, there being no class meetings for pref holders is also no accident.

A better question to consider is this: if the listing documents had spoon fed the cancellation rights at par, would the prefs have ever gone to the premia they reached, or even 160%?

If not, why would an investor retain such prefs at current levels?

Chris

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Re: Preference shares -- keeping it simple

#147213

Postby Alaric » June 21st, 2018, 11:14 pm

ChrisNix wrote:The cancellation rights are not down to poor drafting, they are 'traditional' for UK prefs. Furthermore, there being no class meetings for pref holders is also no accident.


Your evidence for these assertions?

Even if you are right, the observation that the FSA or FCA were asleep is relevant as they should have stepped in to remind market makers of these embedded options. To an investor looking for perpetual income, what differences are there between undated corporate bonds, Preference shares and Building Society PIBS? Elsewhere on this site it seems established that the legal structure of PIBS doesn't include borrower repayment options at par.

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Re: Preference shares -- keeping it simple

#147221

Postby GoSeigen » June 21st, 2018, 11:46 pm

Alaric wrote:
ChrisNix wrote:The cancellation rights are not down to poor drafting, they are 'traditional' for UK prefs. Furthermore, there being no class meetings for pref holders is also no accident.


Your evidence for these assertions?


He wasn't asserting anything, just stating the bleeding obvious.

EVERY single company in the UK for over 70 years has issued irredeemable shares under the same Company Law and similar model articles. You do know that don't you?

Yet we retail investors think we have suddenly spotted a drafting error??!

GS

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Re: Preference shares -- keeping it simple

#147223

Postby Alaric » June 21st, 2018, 11:56 pm

GoSeigen wrote:EVERY single company in the UK for over 70 years has issued irredeemable shares under the same Company Law and similar model articles. You do know that don't you?


It's your claim then that as soon as Prefs went above par that the FSA or FCA should have stepped in to remind the market that issuers had unrestricted rights to pay off investors at par? That's distinct from PIBS and Corporate Bonds where no such right existed.

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Re: Preference shares -- keeping it simple

#147239

Postby ChrisNix » June 22nd, 2018, 8:31 am

Alaric wrote:
It's your claim then that as soon as Prefs went above par that the FSA or FCA should have stepped in to remind the market that issuers had unrestricted rights to pay off investors at par? That's distinct from PIBS and Corporate Bonds where no such right existed.


Alaric,

The FSA didn't really get going until 2001, by which time most of these prefs had already been issued. I doubt it even considered prefs much in the first few years.

Further, it is wrong to state that issuers had an unrestricted right to cancel. The court typically puts a company through the third degree, in order to be confident, before sanctioning a scheme, that the interests of creditors are not being materially affected. Cancellations have been known to be turned down.

The information was all in the market place, even if few took the time to work through it, so the FSA couldn't have properly determined that an issuer was required to release further information. So no argument for a "profit warning". Do you believe the FSA/FCA ought to have issued a press release on the workings of the CA? I do believe it feels an update is overdue.

In all this, one other fundamental factor seems to have been skipped over on this blog. For a pref to justify selling at a big premium, not only does the risk of cancellation at par have to be extremely remote, but also the risk of dividends being passed has to be negligible. As the events of 2008 showed that is often not the case for issuers who are big financial institutions.

Chris

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Re: Preference shares -- keeping it simple

#147242

Postby GoSeigen » June 22nd, 2018, 8:45 am

Alaric wrote:
It's your claim
then that as soon as Prefs went above par that the FSA or FCA should have stepped in to remind the market that issuers had unrestricted rights to pay off investors at par?


Sorry, where did I say that? That's a straw man argument. Try again.

GS

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Re: Preference shares -- keeping it simple

#147244

Postby Wizard » June 22nd, 2018, 9:09 am

GoSeigen wrote:
Wizard wrote:If the FCA wished to rectify a poorly informed market then clear Q&As saying something like "...for the avoidance of doubt, the use of the term irredeemable does not preclude a capital reduction at par..." would be the way to do it, not the publication of the prospectus and articles which make no mention of the CA / capital reduction. I think quite the opposite is the case and the FCA wants to maintain a degree of opacity.


This assertion in bold is simply not true. Every instance of Articles of Association I have looked at incorporates/refers directly to the Companies Act**. Not that they need to... the Companies Act is superior to the Articles and applies whether they mention it or not: a company may not break the Companies Acts with impunity as any competent company secretary or director should know very well.



GS
[**The original assertion can be shown to be true by presenting a single example of Articles which do not mention the Companies Act, which should be pretty easy.]


You are of course right GS and I need to stop posting after midnight when I am rushing posts. My point was rather that there is nothing to make clear the interaction of the Companies Act and the basis of issuances in these documents, something along the lines of the "...for the avoidance of doubt..." statement that I suggested. There is reference to capital reduction in your articles (of Lloyds for example) and then have a prospectus for an instrument which includes the word irredeemable in its name. Having looked at the LLPC / LLPD prospectus they do not then (as far as I can see) define irredeemable, rather they have a defined term for Redeemable which says something along the lines of 'all the prefs other than LLPC and LLPD'. Given this I do not think the situation is particularly clear and I understand why Bailey says there is "...reasonable confusion...".

To avoid any further confusion here I am not saying your analysis of the situation is wrong, just that I think it is not unreasonable for investors to have not reached that conclusion before the whole Aviva storm blew up.

Indeed, the reason I think Bailey is not pushing for the clarity over and above the articles and prospectus is that he has been advised that the right to use a reduction of capital at par is quite probably there. If this is made crystal clear then I imagine the price of the prefs would all fall significantly and he does not want to have to deal with that. Better maybe to leave it unclear but have a quiet word with the Chairmen of the issuers and point out that 'the establishment' would not view any attempt to use a capital reduction at par at all favourably. All speculation on my part of course.

Terry.

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Re: Preference shares -- keeping it simple

#147245

Postby Alaric » June 22nd, 2018, 9:11 am

GoSeigen wrote:Sorry, where did I say that?


You have repeatedly claimed that the right to cancel Preference Shares at par without the consent of the holders has always been present. If that was the case, then in around 2010 or whenever interest rates and default risk fell by enough to take the prices over par, the FCA or FSA if it still existed could have stepped in to remind the market of an implicit ceiling on the price. It's my case that no such right should exist, or that if it did, it only arises by virtue of poor drafting. Certainly no such action was taken and the FCA only got involved when Aviva pulled the repayment rabbit out of a hat earlier this year.

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Re: Preference shares -- keeping it simple

#147249

Postby stockton » June 22nd, 2018, 9:21 am

ChrisNix wrote:Alaric,

The cancellation rights are not down to poor drafting, they are 'traditional' for UK prefs. Furthermore, there being no class meetings for pref holders is also no accident.

A better question to consider is this: if the listing documents had spoon fed the cancellation rights at par, would the prefs have ever gone to the premia they reached, or even 160%?

If not, why would an investor retain such prefs at current levels?

Chris

The question is surely "Why would an investor ever buy such prefs. at issue ?"
If I went to a shop and bought a bed I would be somewhat surprised if the shop insisted that they were entitled to recover the bed should the RRP rise. Given that the whole point of the purchase is to possess the bed I would almost certainly shop elsewhere.
And given that inflation was usually significantly higher when these prefs. were issued the incentive to shop elsewhere would be considerable.

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Re: Preference shares -- keeping it simple

#147259

Postby ChrisNix » June 22nd, 2018, 9:57 am

stockton wrote:
ChrisNix wrote:Alaric,

The cancellation rights are not down to poor drafting, they are 'traditional' for UK prefs. Furthermore, there being no class meetings for pref holders is also no accident.

A better question to consider is this: if the listing documents had spoon fed the cancellation rights at par, would the prefs have ever gone to the premia they reached, or even 160%?

If not, why would an investor retain such prefs at current levels?

Chris

The question is surely "Why would an investor ever buy such prefs. at issue ?"
If I went to a shop and bought a bed I would be somewhat surprised if the shop insisted that they were entitled to recover the bed should the RRP rise. Given that the whole point of the purchase is to possess the bed I would almost certainly shop elsewhere.
And given that inflation was usually significantly higher when these prefs. were issued the incentive to shop elsewhere would be considerable.


Stockton,

Such prefs were priced so that the initial yield would have them selling at close to par. Indeed, it appears there was sometimes a last minute variation which lead to an issue price just above £1. This yield would have taken into account inflation expectations.

What you have overlooked is the income derived from them.

An investor got a good yield, which would persist until and unless he got his money back. In almost all cases, the issuer, having gone to the time and expense of making an issue, was unlikely to return the capital within, say, five years.

So a nice little medium term earner.

A better comparison is a bank deposit, but rates could not be fixed on these for any decent length of time.

Very few investors were investing for capital gain. As one observer put it, fixed interest instruments were the defenders and equites the strikers.

Chris

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Re: Preference shares -- keeping it simple

#147273

Postby Alaric » June 22nd, 2018, 10:40 am

ChrisNix wrote:An investor got a good yield, which would persist until and unless he got his money back. In almost all cases, the issuer, having gone to the time and expense of making an issue, was unlikely to return the capital within, say, five years.


Those buying such income were likely to have been buying for an indefinite period, far longer than five years. Whilst it would include individuals financing their retirement and those managing income funds, it could also include defined benefit pension funds and insurance company annuity funds who would have both a lifetime guarantee to meet and solvency requirements to match assets to liabilities. These requirements are not met if the issuer has the right to renege on the income at a time of their choosing because interest rates have fallen.

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Re: Preference shares -- keeping it simple

#147302

Postby GoSeigen » June 22nd, 2018, 11:59 am

ChrisNix wrote:
stockton wrote:The question is surely "Why would an investor ever buy such prefs. at issue ?"


Very few investors were investing for capital gain. As one observer put it, fixed interest instruments were the defenders and equites the strikers.


It's worth revisiting something a bit curious about the way preference shares are being viewed. The usual ranking of investment risk is that:

-money and equivalents are the most riskless assets: hence "a bird in hand is worth two in the bush", "cold hard cash", "cash is king" etc.;
-then less secure is dated government securities where cash will be repaid with a high degree of certainty on a set date with certain interest payments;
-then we have dated corporate debt where again cash flows are fairly certain, but with appreciable credit risk and higher coupons in compensation;
-even more risky are securities where no date is set for return of principal: bonds give a sure income stream but
-preference shares and ordinary shares cannot even offer security of income: their dividends are absolutely discretionary and principal does NOT have to be repaid.


So traditionally, and even now for savvy investors, preference shares are down there with junk: it is a critical disadvantage not to know when your principal will be repaid in cash.

So the simple answer to stockton's question is that prefs had higher dividend rates than deposit interest, higher dividend rates than dated government debt, higher dividend rates than dated corporate debt and higher dividend rates than undated corporate debt. No mystery: they earned a higher return to compensate for their greater risk.


One cannot overemphasise how the psychology shown in this discussion is the reverse of the above and, frankly perverse [pref shares are "a safe, secure income"!!!] . Investors are approaching the preference share question as if it is an advantage not to have the right to be repaid principal. This is utterly misguided and just a fashion, a product of elevated asset prices and low yields generally.


If one truly wants to understand what Chris Nix and others are saying then one needs to return to the orthodox mindset where cash is safe and undated equity is junk. Surely it doesn't need to be spelled out why this is the case and what the risks are. Aviva exposed merely one risk (loss of capital through overpaying at purchase), but it is not remotely the only risk to investors of these junky assets.

Gilt yields below 1% may be the lipstick on the preference share pig, but to mix metaphors: wake up and smell the piggy before it's too late.


GS

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Re: Preference shares -- keeping it simple

#147315

Postby ChrisNix » June 22nd, 2018, 12:28 pm

Alaric wrote:
ChrisNix wrote:An investor got a good yield, which would persist until and unless he got his money back. In almost all cases, the issuer, having gone to the time and expense of making an issue, was unlikely to return the capital within, say, five years.


Those buying such income were likely to have been buying for an indefinite period, far longer than five years. Whilst it would include individuals financing their retirement and those managing income funds, it could also include defined benefit pension funds and insurance company annuity funds who would have both a lifetime guarantee to meet and solvency requirements to match assets to liabilities. These requirements are not met if the issuer has the right to renege on the income at a time of their choosing because interest rates have fallen.


Alaric,

It was for an indefinite period, because the timing of any return of capital is uncertain.

I am almost certain that, other than a tiny minority, none were buying for more than twenty years.

Pension funds until the last ten years or so did not really match their liabilities with assets. I very much doubt insurers were back then matching ten years plus liabilities with prefs. Nowadays if they match it is with corporate bonds and gilts.

I think maybe where you're struggling is that the right to cancel is not purely contractual, relying as it does on the interaction with the CA. The prefs are best thought of having no fixed date when they can be redeemed, nor cancelled for that matter. They are not and never have been everlasting. As the judge said fifty years ago in Saltdean Estate;

"The fact is that every holder of preferred shares of the company has always been at risk that his hope of participating in undrawn or future profits of the company might be frustrated at any time by a liquidation of the company or a reduction of its capital properly resolved on by a sufficient majority of his fellow members. This vulnerability is and has always been a characteristic of the preferred shares. Now that the event has occurred, none of the preferred shareholders can, in my judgment, assert that the resulting state of affairs is unfair to him."

There is simply no reneging involved!

Notwithstanding this, the prefs were very popular in the early 90s. It is of course conjecture as to how long the initial investors' horizons were. I'm pretty sure all would have expected five years plus, and a load of factors could easily have been imagined which would have lead to the expectation amongst some of a rather longer investment period, during which the prospect of juicy dividends was an attraction. In fact, most of the initial investors have had 25 years plus, so even by your (extremely dubious) standards the issuers have not been precipitous!

As for those who bought in the last five or so years, I don't think they have even that straw to clutch at.

Chris

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Re: Preference shares -- keeping it simple

#147323

Postby PeterGray » June 22nd, 2018, 12:43 pm

GoSeigen wrote:...
So the simple answer to stockton's question is that prefs had higher dividend rates than deposit interest, higher dividend rates than dated government debt, higher dividend rates than dated corporate debt and higher dividend rates than undated corporate debt. No mystery: they earned a higher return to compensate for their greater risk.
...
GS


That statement is clearly true, but I don't think it's really the answer to stockton's question.

Prefs have higher dividend rates than the other objects you mention because - their dividends (in most cases) were more easily stopped or suspended and they came lower down the pecking order in terms of capital return in case of failure. The added risk does not necessarily have to have included a perception of an ability to repay at par without a class vote.

Peter

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Re: Preference shares -- keeping it simple

#147358

Postby GoSeigen » June 22nd, 2018, 2:53 pm

PeterGray wrote:
GoSeigen wrote:...
So the simple answer to stockton's question is that prefs had higher dividend rates than deposit interest, higher dividend rates than dated government debt, higher dividend rates than dated corporate debt and higher dividend rates than undated corporate debt. No mystery: they earned a higher return to compensate for their greater risk.
...
GS


That statement is clearly true, but I don't think it's really the answer to stockton's question.

Prefs have higher dividend rates than the other objects you mention because - their dividends (in most cases) were more easily stopped or suspended and they came lower down the pecking order in terms of capital return in case of failure.

Agree.
The added risk does not necessarily have to have included a perception of an ability to repay at par without a class vote.


Also agree, but I'm not sure I implied otherwise did I? All I was saying was that compared to less risky assets the dividend offered was better so what was wrong with the bargain? Remember: getting your principal back (e.g. through capital reduction of paid up share capital) is good, not bad -- that is my point. The current fashion is for the opposite which I view as mildly irrational / risky investment behaviour.

GS
[EDIT: to frame the whole argument a different way: for stockton to understand the motivation of original subscribers to the prefs it is not enough for him to imagine what he would be thinking at the time of issue -- he additionally has put put himself in the shoes of the subscribers and see the bargain with their biases and priorities, rather than his own. Specifically, subscribers viewed IMO return of principal as a good thing whereas current investors see it as bad -- they want a so-called uninterrupted safe and secure income].

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Re: Preference shares -- keeping it simple

#147476

Postby Alaric » June 23rd, 2018, 9:28 am

GoSeigen wrote:So the simple answer to stockton's question is that prefs had higher dividend rates than deposit interest, higher dividend rates than dated government debt, higher dividend rates than dated corporate debt and higher dividend rates than undated corporate debt. No mystery: they earned a higher return to compensate for their greater risk.


There's an even greater risk if the issuer can cancel the income because "they want to", without the holders having effective power of veto. That was what Aviva claimed they had the power to do.


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