Explaining pref shares
IN YOUR REPORT on preference shares (8 February), you state: “We simply don’t know and nobody has come up with a satisfactory explanation” for why the market marked Absa prefs down from 63% to 70% of prime.
There’s a very simple reason for that rerating that’s obvious to anyone who trades preference shares rather than just writing about them. That reason is supply and demand. Absa issued R3bn prefs, thereby satisfying demand for tier one prefs. That was followed by Netcare’s large issue, which did the same for the second tier prefs.
That basic understanding of markets also makes sense of why the most recent pref issues have been at the highest percentages of prime. It has nothing to do with credit quality and everything to do with the overhang of supply over demand. This market is relatively insensitive to credit quality within the tier one (top bank) and tier two (everything else) bands.
By way of demonstration, Absa has the highest credit rating of tier one prefs but trades at a higher percentage of prime than any of the others. In the second tier, Steinhoff’s prefs are trading at a higher yield than Astrapak’s.
An implication of the supply/demand story is that there’s no such thing as a “right” price for preference shares to trade at – irrespective of what level they were issued at. Though demand increases marginally as the percentage of prime paid increases, supply is increasing much more quickly.