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Preference shares -- keeping it simple

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

#150050

Postby GoSeigen » July 4th, 2018, 10:52 pm

stockton wrote:In reality, who would ever define redemption in such a way as to exclude a reduction of capital ?

In the case of share capital (and debentures), this is exactly how the Companies Acts define redemption. Very simply answer. It is in the Companies Act which every set of Articles used by any UK company refers to.


ONLY SHARES THAT ARE CREATED REDEEMABLE AT ISSUE CAN BE REDEEMED. (i.e. very few shares)

EVERY AND ANY SHARE EVER ISSUED IS SUBJECT TO CAPITAL REDUCTION.


They simply cannot be the same thing on any rational understanding of UK company law. Referring to redemption of shares in any other way is a misuse of the term through carelessness or ignorance.

GS

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Re: Preference shares -- keeping it simple

#150076

Postby ChrisNix » July 5th, 2018, 8:00 am

Alaric wrote:
ChrisNix wrote:I'd paraphrase the European (and Australian) situation as, in cases not overseen by a court, requiring a 75% vote of the affected class. Not relevant here.


From an investor viewpoint I'd want protection against the risk that the issuer of an income paying security terminates it at below market value. That's why loans are sometimes secured on assets. If there isn't the compulsion of a class vote, then investor protection is wanting and thus the calls for the FCA to do something about it.

Perhaps a real point is that in a relatively small market where in a number of cases the issuers of Prefs were also at arms length the holders, that there was a general consensus for managements to behave and that there shouldn't be embedded options to repay Prefs that had arisen above par. Aviva tried to break this until they climbed down. It's still a weakness in the legal and regulatory system that the wordings on return of capital and absence of a compulsory class vote make this possible.


Alaric,

I'm afraid your view is now merely of academic interest.

The legal terms of almost all of these prefs were set 20 years ago or more.

Whilst the law may ultimately be changed, the changes wouldn't be retrospective, so the terms of existing prefs will be respected (unchanged).

Any prospective change is very likely to be pretty irrelevant. When these prefs were issued there was no real corporate bond market in the UK, and many investors had the benefit of the ACT tax credit, abolished in 1998, I think. There was heavy demand for a five year plus fixed income instrument and a plethora of issues in the first half of the 90s.

Since then issuers in similar circumstances have overwhelmingly turned to corporate bonds. Any future pref issues (new or old laws) will be very few and far between!

For now, if you invest in already issued prefs you are accepting terms which, other than in BP, do not link cancellation to market price.

Chris

P.S. If a redeemable pref were selling at 50% above the redemption price, do you think the market price ought to be 'protected'?

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Re: Preference shares -- keeping it simple

#150087

Postby Alaric » July 5th, 2018, 8:56 am

ChrisNix wrote:When these prefs were issued there was no real corporate bond market in the UK, and many investors had the benefit of the ACT tax credit, abolished in 1998, I think.


Corporate Bonds/Debentures/Loan Stocks were plentiful in the 1980s and 1990s, just not available to retail investors by virtue of the minimum purchase size.

ACT did present a reason for borrowing in the form of Preference Shares rather than dated or undated Corporate Bonds. I don't believe embedding an open ended repayment option in the event of a rise in interest rates was ever intended and had the combination of interpretations of a return of capital clause and the lack of protection from the absence of a compulsory class vote been noted at the time, the terms of the issues would likely be different.

The pricing of Prefs is still such that the risk of unilateral capital repayment is largely ignored. It remains a tenuous legal assertion that it is possible and any issuer attempting it would likely face legal challenges. Not necessarily from private investors but from institutional investors holding the stock for long term income.

ChrisNix wrote:
P.S. If a redeemable pref were selling at 50% above the redemption price, do you think the market price ought to be 'protected'?


When you say redeemable pref what do you mean by that term? Is there a fixed date at which the money will be returned at 100? Or are you asserting the existence of a lender's right to repay at 100 at a date and time of their choosing?

Moderator Message:
I think we are back in that ever decreasing spiral again. ChrisNix's quote above is unequivocal. If a pref is redeemable, then it has a redemption date or dates. If anyone buys a pref above its par value, then it is a case of caveat emptor.

TJH

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Re: Preference shares -- keeping it simple

#150101

Postby ChrisNix » July 5th, 2018, 9:28 am

Alaric wrote:
ChrisNix wrote:When these prefs were issued there was no real corporate bond market in the UK, and many investors had the benefit of the ACT tax credit, abolished in 1998, I think.


Corporate Bonds/Debentures/Loan Stocks were plentiful in the 1980s and 1990s, just not available to retail investors by virtue of the minimum purchase size.


Alaric,

If you look at the data on corporate bonds, you'll find that there were no indices and little 'market pricing' information prior to 1998. Granted there were quite a number of, mainly smallish debentures, etc., but large corporate borrowing was almost all bank related.

Chris

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Re: Preference shares -- keeping it simple

#150132

Postby Alaric » July 5th, 2018, 11:07 am

ChrisNix wrote:Granted there were quite a number of, mainly smallish debentures, etc., but large corporate borrowing was almost all bank related.


Working as a liability valuation actuary in the 1980s and 1990s, there were plenty of Loan Stocks, Debentures and Corporate Bonds. What else would you use for cash flow matching of annuity liabilities if you wanted a better return than on Gilts?

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Re: Preference shares -- keeping it simple

#150143

Postby ChrisNix » July 5th, 2018, 11:35 am

Alaric wrote:
ChrisNix wrote:Granted there were quite a number of, mainly smallish debentures, etc., but large corporate borrowing was almost all bank related.


Working as a liability valuation actuary in the 1980s and 1990s, there were plenty of Loan Stocks, Debentures and Corporate Bonds. What else would you use for cash flow matching of annuity liabilities if you wanted a better return than on Gilts?


Alaric,

By coincidence, I am also not unacquainted with cash flow matching, in my case by pension schemes.

I have acknowledged that there were a number of bonds around back then, but that's not the point.

Do you dispute that the UK corporate bond market has expanded massively since 1998?

Chris

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Re: Preference shares -- keeping it simple

#150163

Postby Alaric » July 5th, 2018, 12:30 pm

ChrisNix wrote:Do you dispute that the UK corporate bond market has expanded massively since 1998?


I dispute that it was small and insignificant before that. I also dispute that for a new Pref Issue in the early 1990s that either party had an expectation that there was a repayment option at a non-market price should interest rates fall significantly. The concept of options against interest rates changes and whether or not they were "in the money" had already been established.

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Re: Preference shares -- keeping it simple

#150174

Postby ChrisNix » July 5th, 2018, 12:47 pm

Alaric wrote:
ChrisNix wrote:Do you dispute that the UK corporate bond market has expanded massively since 1998?


I dispute that it was small and insignificant before that. I also dispute that for a new Pref Issue in the early 1990s that either party had an expectation that there was a repayment option at a non-market price should interest rates fall significantly. The concept of options against interest rates changes and whether or not they were "in the money" had already been established.


Alaric,

You seem to be ducking the issue regarding the relative size of the corporate bond market! The essential point is that a putative issuer of a subordinated instrument now would see the corporate bond market as a much more natural place to pitch.

As for expectations, I can't speak for the original subscribers. What I can state unequivocally is that any potential subscriber which checked the usual legal rights of UK listed prefs would have been aware that the default setting was that they could be cancelled at par. This was made clear by the HoF case only a few years early. Useful summary in this link: https://swarb.co.uk/house-of-fraser-plc ... d-hl-1987/.

The harsh truth is that the market price ought to have reflected the cancellation position to some degree. As commented previously, the more plausible explanation for premia is that the large IIs considered they had a 'ord share veto' over same. N.B. This wasn't a bond instrument, where the prospectus and trust deed encapsulated the terms, and to which 'options' against interest rate were relevant.

Nonetheless, such prefs were fine for shorter term cash flow matching, but were not appropriate for long term matching against a bond based measure of liabilities.

Luncheon beckons...

Chris

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Re: Preference shares -- keeping it simple

#150180

Postby Alaric » July 5th, 2018, 12:54 pm

ChrisNix wrote: This was made clear by the HoF case only a few years early. Useful summary in this link: https://swarb.co.uk/house-of-fraser-plc ... d-hl-1987/.


From a mathematical viewpoint, that judgement was complete nonsense. If you have a stream of income that unfettered is worth 1.5X and you are offered X for it, how does this not affect your rights?

Pref Issues that post dated this judgement would attempt to make it so that it didn't apply. Applying a class vote being one such solution, issuing enough Pref shares to constitute a blocking majority being another. Not with complete success it would seem.

If you are, say, a General Accident Pref holder, the risk of a coercive payback is just as much a default risk as Aviva, GA's parent, going bust. The FCA are now at least monitoring these potential elective defaults.

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Re: Preference shares -- keeping it simple

#150286

Postby ChrisNix » July 5th, 2018, 6:06 pm

Alaric wrote:
ChrisNix wrote: This was made clear by the HoF case only a few years early. Useful summary in this link: https://swarb.co.uk/house-of-fraser-plc ... d-hl-1987/.


From a mathematical viewpoint, that judgement was complete nonsense. If you have a stream of income that unfettered is worth 1.5X and you are offered X for it, how does this not affect your rights?

Pref Issues that post dated this judgement would attempt to make it so that it didn't apply. Applying a class vote being one such solution, issuing enough Pref shares to constitute a blocking majority being another. Not with complete success it would seem.

If you are, say, a General Accident Pref holder, the risk of a coercive payback is just as much a default risk as Aviva, GA's parent, going bust. The FCA are now at least monitoring these potential elective defaults.


Alaric,

Taking the last statement first, without being an expert on the creditworthiness of Aviva, I think it is safe to say that the probability of a cancellation at par for GNA prefs is far, far greater than that of an Aviva default. Compliance with law and the terms of an instrument is not coercion in the eyes of most people, and certainly not in those of the courts.

If it was an essential requirement that the prefs had a veto, the original subscribers ought to have insisted on one. One can only conclude their appetite for the prefs led them to cut corners.

It is not the judgement which is faulty it is your maths. The stream of income was not unfettered so the equation ought to have been MV = NPV at required rate of return of dividend stream and cancellation price, from the time of calculation to a reasonable estimate of when a cancellation might be expected to occur. GS has suggested three years as a relatively 'safe' period, which seems reasonable to me. If the required rate of return has fallen below the dividend rate, then the pref would be expected to sell at a premium, not an enormous one such as 1.5x.

The reason such a cancellation is not a variation of rights is as set out in the following HoF excerpt, which follows the consistent reasoning of the previous 30 years:
‘The reduction of capital now proposed to be made gives effect to that right [that the second preference shareholders were entitled to priority of repayment after certain preferences shares and before any other shareholders on a reduction of capital]. This necessarily involves, of course, that all other rights attached to the shares will come to an end, but that is something to which the holders of the shares must be taken to have agreed as a necessary consequence of their right to prior repayment receiving effect.

Chris

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Re: Preference shares -- keeping it simple

#150305

Postby Alaric » July 5th, 2018, 7:25 pm

ChrisNix wrote: Compliance with law and the terms of an instrument is not coercion in the eyes of most people, and certainly not in those of the courts.


It's coercion in my eyes. There's a stream of payments which stretches out to infinity. If the payor wants an option to be able to cancel that stream at a time of their notice and pay below market price, they should pay for being granted the option. For example by paying a higher coupon than on a superficially similar instrument such as PIBS which don't have such coercive rights.

Whatever your views or those of GS, it does not seem as they are shared by the FCA or market makers who don't believe Prefs will run for a maximum of three years before being paid off at par by legal trickery. It may only be a soft prevention in that no issuer will want to fight both the legality and applicability of their capital repayment clause and the denial of class rights through the Courts, but for as long as it's there, it can be assumed that Prefs will continue at their present Coupons for ever or until terminated at a price related to the value of the infinite income stream. Pref holders are "members of the Company" as are Ordinary shareholders, therefore directors have a supposed duty towards them, rather than short-changing them to the benefit of Ords. Financial issuers are likely to want to do something by 2026 when the rules about solvency capital are changing.

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Re: Preference shares -- keeping it simple

#150308

Postby Tara » July 5th, 2018, 7:40 pm

From a mathematical viewpoint, that judgement was complete nonsense. If you have a stream of income that unfettered is worth 1.5X and you are offered X for it, how does this not affect your rights?

Is it not the case that the House of Fraser preference shares were trading at prices well below par before the reduction of capital ? If so then they received X for their shares when their shares were trading at perhaps 0.5X. What was it that the House of Fraser preference shareholders did not like ? It seems that the House of Fraser preference shareholders were very well treated and very well rewarded.

Is anyone aware of any cases where the preference shares were trading at prices well above par before the reduction of capital, and where the preference shareholders faced a very large loss of their capital ?

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Re: Preference shares -- keeping it simple

#150330

Postby Alaric » July 5th, 2018, 8:40 pm

Tara wrote:Is it not the case that the House of Fraser preference shares were trading at prices well below par before the reduction of capital ?


That may well be so and it's strange that this salient fact is missing from the summaries of the background to this case. If the Prefs did stand below par, the complainants must have had some another cause for complaint other than direct financial loss.

In the 1970s, it used to be common for debentures and loan stocks to be stated as liabilities at par. The rise in interest rates had forced prices well down. At the cost of increased debt servicing in the future, it was possible for companies with surplus cash or continued ability to borrow, to make a paper profit by buying back the loans at market price. So if you removed 100 from the liabilities balance sheet at a cost in cash or renewed borrowing of say 70, there was a paper profit to be made.

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Re: Preference shares -- keeping it simple

#150355

Postby ChrisNix » July 5th, 2018, 11:09 pm

Tara wrote:From a mathematical viewpoint, that judgement was complete nonsense. If you have a stream of income that unfettered is worth 1.5X and you are offered X for it, how does this not affect your rights?

Is it not the case that the House of Fraser preference shares were trading at prices well below par before the reduction of capital ? If so then they received X for their shares when their shares were trading at perhaps 0.5X. What was it that the House of Fraser preference shareholders did not like ? It seems that the House of Fraser preference shareholders were very well treated and very well rewarded.

Is anyone aware of any cases where the preference shares were trading at prices well above par before the reduction of capital, and where the preference shareholders faced a very large loss of their capital ?


Tara,

I haven't seen the HoF judgement itself so can't comment on pricing. Have you seen a reference?

In Hunting plc 2004, the prefs were trading at 118pence per pound when the court confirmed a cancellation at £1.

Hope that helps.

Chris

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Re: Preference shares -- keeping it simple

#150358

Postby Alaric » July 6th, 2018, 12:09 am

ChrisNix wrote:In Hunting plc 2004, the prefs were trading at 118pence per pound when the court confirmed a cancellation at £1.

To complicate the issue, the Hunting Prefs contained a conversion option.

The Company is also posting today a circular to holders of its Convertible
Preference Shares reminding them of their right to convert them into Ordinary
Shares of 25 pence each in the capital of the Company, on the basis of 34
Ordinary Shares for every £100 of nominal Convertible Preference Shares
converted. The conversion date is 1 July 2004.


Was that conversion right "in the money"?

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Re: Preference shares -- keeping it simple

#150384

Postby ChrisNix » July 6th, 2018, 8:44 am

Alaric wrote:
ChrisNix wrote:In Hunting plc 2004, the prefs were trading at 118pence per pound when the court confirmed a cancellation at £1.

To complicate the issue, the Hunting Prefs contained a conversion option.

The Company is also posting today a circular to holders of its Convertible
Preference Shares reminding them of their right to convert them into Ordinary
Shares of 25 pence each in the capital of the Company, on the basis of 34
Ordinary Shares for every £100 of nominal Convertible Preference Shares
converted. The conversion date is 1 July 2004.


Was that conversion right "in the money"?


Alaric,

Having been in the money, the ord price fell sharply and the conversion value went to well below the cancellation price. It appears the 118p was based on running yield.

Chris

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Re: Preference shares -- keeping it simple

#150403

Postby stockton » July 6th, 2018, 9:56 am

GoSeigen wrote:
stockton wrote:In reality, who would ever define redemption in such a way as to exclude a reduction of capital ?

In the case of share capital (and debentures), this is exactly how the Companies Acts define redemption. Very simply answer. It is in the Companies Act which every set of Articles used by any UK company refers to.


ONLY SHARES THAT ARE CREATED REDEEMABLE AT ISSUE CAN BE REDEEMED. (i.e. very few shares)

EVERY AND ANY SHARE EVER ISSUED IS SUBJECT TO CAPITAL REDUCTION.


They simply cannot be the same thing on any rational understanding of UK company law. Referring to redemption of shares in any other way is a misuse of the term through carelessness or ignorance.

GS

A swallow is a bird -that does not make every bird a swallow.

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Re: Preference shares -- keeping it simple

#150421

Postby ChrisNix » July 6th, 2018, 10:50 am

Alaric wrote:
ChrisNix wrote: Compliance with law and the terms of an instrument is not coercion in the eyes of most people, and certainly not in those of the courts.


It's coercion in my eyes. There's a stream of payments which stretches out to infinity. If the payor wants an option to be able to cancel that stream at a time of their notice and pay below market price, they should pay for being granted the option. For example by paying a higher coupon than on a superficially similar instrument such as PIBS which don't have such coercive rights.

Whatever your views or those of GS, it does not seem as they are shared by the FCA or market makers who don't believe Prefs will run for a maximum of three years before being paid off at par by legal trickery. It may only be a soft prevention in that no issuer will want to fight both the legality and applicability of their capital repayment clause and the denial of class rights through the Courts, but for as long as it's there, it can be assumed that Prefs will continue at their present Coupons for ever or until terminated at a price related to the value of the infinite income stream. Pref holders are "members of the Company" as are Ordinary shareholders, therefore directors have a supposed duty towards them, rather than short-changing them to the benefit of Ords. Financial issuers are likely to want to do something by 2026 when the rules about solvency capital are changing.


Alaric,

* There's a stream of payments which stretches out to infinity. FALSE

* If the payor wants an option to be able to cancel that stream at a time of their notice and pay below market price, they should pay for being granted the option. WRONG WAY AROUND! CANCELLATION IS AN INNATE QUALITY OF UK SHARES. IF THE PAYEE WANTS TO PREVENT CANCELLATION IT NEEDS TO HAVE AN ARTICLE INSERTED TO THAT EFFECT. HOW MUCH WOULD PREF HOLDERS PAY FOR THAT NOW -- 50P?

I very much doubt that the FCA has a view on the period that prefs might not be cancelled for. Its concern is that the market is properly informed that cancellation at par is possible. As for the market makers, the truth is there is no market in institutional size. If an II rocked up and asked for a firm bid for 5m LLPD shares I very much doubt they'd get more than 130p, and quite likely less, or no bid.

* it can be assumed that Prefs will continue at their present Coupons for ever or until terminated at a price related to the value of the infinite income stream. FANTASTICAL :roll:

* Pref holders are "members of the Company" as are Ordinary shareholders, therefore directors have a supposed duty towards them, rather than short-changing them to the benefit of Ords. THE DIRECTORS DUTY IS TO THE COMPANY. WITHIN THAT THEIR ONLY DUTY TO THE PREFS IS TO ENSURE THEIR RIGHTS ARE COMPLIED WITH - NOT TO MAXIMISE THEIR VALUE. IN FACT, IF THE VALUE OF THE FIRM CAN BE INCREASED BY CANCELLING THE PREFS THE DIRECTORS IF ANYTHING HAVE A DUTY TO DO SO.

Chris

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Re: Preference shares -- keeping it simple

#150422

Postby Alaric » July 6th, 2018, 10:54 am

stockton wrote:A swallow is a bird -that does not make every bird a swallow.


That shares can have a return of capital isn't really the point, it's the amount repaid that's the issue at question. Could a Company repay almost all its ordinary share capital at face value, with much of the rest of the Company value disappearing into Director bonuses? I suspect they could, but Ordinary shareholders are not in normal circumstances going to accept 10p for a share priced at £ 2, even if the nominal amount is 10p.

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Re: Preference shares -- keeping it simple

#150425

Postby Alaric » July 6th, 2018, 11:04 am

ChrisNix wrote:* If the payor wants an option to be able to cancel that stream at a time of their notice and pay below market price, they should pay for being granted the option. WRONG WAY AROUND! CANCELLATION IS AN INNATE QUALITY OF UK SHARES. IF THE PAYEE WANTS TO PREVENT CANCELLATION IT NEEDS TO HAVE AN ARTICLE INSERTED TO THAT EFFECT. HOW MUCH WOULD PREF HOLDERS PAY FOR THAT NOW -- 50P?


Preference Shares are competing for investor's attention with other undated security types such as PIBS and undated Corporate Bonds. From that viewpoint additional risks need to be paid for and paid for by the borrower or excluded by the documentation.

I view Prefs as Bonds masquerading as Shares. That used to matter because of the tax treatment, the income being paid after deduction of tax, thus enabling reclaims. Once Gordon abolished the tax reclaims relief enjoyed by gross investors, they had less point.


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