Shedding light on prefs
THANK YOU for your further article on variable rate preference shares in Finweek of 8 February.
At the risk of belabouring the issue, it seems, with respect, that you are still missing a vital point on the pricing of these instruments.
While I agree that the rate at which the dividends are linked to prime is important upon their initial issue (as yield would be when issuing a new gilt), thereafter it becomes quite simply a question of pricing the dividend flowing from these instruments…ie in exactly the same way as gilts are continuously re-priced by the market in relation to their interest payments, or the manner in which commercial properties are valued as a function of the rental income produced. The difference in the case of pref shares being the variability of that cash flow and its tax-free status.
The crisp issue therefore, is to determine what capital value should be attached to each rand of dividend flow…ie if the preference share is to be priced to yield (say) 6,5% to the investor, then each rand of that dividend cash flow would have a capital value of R15,38 (ie100c / 6,5%), and at a 7,0% yield each rand would have a capital value of R14,28, and so on to any given yield that the market thinks is appropriate under prevailing circumstances.
Because the yield at issue date is a matter of historical interest only and bears no significance to pricing thereafter, I see no logical reasons which support your contention that the market price of prefs should necessarily closely orbit their original issue price, any more than a gilt should be priced at par (unless it’s about to be redeemed), or a commercial property should be priced at its construction cost.
In view of the significant tax advantage offered by variable rate pref shares to individuals paying a high rate of marginal tax, it seems that the approximate 8,5% yield currently attached by the market to most of the listed bank preference shares is extremely generous, making them very attractively underpriced in today’s market.