Den of The Lion Investor

Soon after the recent OCBC preference shares issuance, OCBC has decided to issue more preference shares to further balance its capital base.

This time round, they will be issuing 10,000,000 preferences share at a price of $100 each. If demand is good, this might be increased to 15,000,000 shares.

Out of these 10,000,000 OCBC preference shares, 2,500,000 will be offered to retail investors while the rest will be offered to institutions.

The retail application will be available via ATM application of Singapore’s three local banks starting from 9am today, until 12 noon on 26th August. The ATM subscription will be subjected to balloting if demand exceeds supply. Since the minimum subsciption this time round is 100 shares (compared to 200 shares previously), more people might be able to apply for it.

The preference shares will provided a dividend of 5.1% per annum which will be paid semi-annually in March and September till 20th September 2008. They are perpertual securities with no fixed maturity dates. They may however, be redeemed by OCBC on 20th September 2008 and each dividend date thereafter (subject to MAS’s approval).

After 20th September 2018, the dividend rate will no longer be fixed at 5.1% p.a. Instead, the rate will be tied to the 3-month Singapore dollar swap offer rate plus 2.5%. Dividends from that point onwards will be payable every 3 months.

The 3-month swap offer rate is a rate that is slightly higher than the 3-month SIBOR. You can find out the historical SIBOR rates from MAS’s financial database. Refer to “interbank 3-month”. For current rates, you can refer to a copy of The Business Times.

The OCBC preference shares are expected to list on SGX from 28th August 2008.

The ATM application for the $50 million second tranche of OCBC preference shares opens from 9am today until noon on 28th July. You can apply for them through the ATM of the 3 local banks - DBS, UOB and OCBC.

Each application requires a minimum subscription of 200 shares priced at $100 each. Additional shares are in multiplies of 100.

Unlike the first tranche which was on a first-come-first-served basis, this ATM tranche will be allocated by balloting if the total subscription exceeds 500,000 shares. That means you do not need to rush down to an ATM machine to apply at 9am today.

However, if you are interested in applying for the shares, it is wise not to wait too long as OCBC might close the tranche anytime if overwhelming demand is received.

Based on the questions received from my previous post on the OCBC preference shares, I think it will be good for me to elaborate more on what preference shares or preferred shares really are.

Preference shares really behave more like a bond than normal shares. Let’s first look at what a normal share is.

A normal share gives you a certain percentage shareholding of a company. You have an economic interest in all future earnings of the company. If there are 100 shares of a company and you own 1 share, effectively you own 1% of the company. If the company is sold, you get 1% of the value. You also get a 1% voting right.

A preferred share is more like a loan to the company. You do not get normal voting rights and to attend AGMs. In return for your capital, you are promised a dividend amount every year. This dividend is not guaranteed and the frequency of payouts will determine on the strength of the company.

This is where a preference share differs from a normal bond. For a bond, the company has to pay the interest no matter what happens. For preference shares, it is conditional upon the company paying dividends to its normal shareholders first. If the company happens to make a loss for that year and decides not to declare any dividends to its normal shareholders, the company can choose not to pay or to reduce the dividends to the owners of its preference shares.

Based on OCBC’s track record, the frequency of dividend payouts should be pretty consistent.

The other difference is that for a bond, it has a fixed maturity date. Come a certain date, you know that you will get back your capital. For preference shares, the company has the right (but not the obligation) to redeem the shares from you on particular dates. If they don’t and you wish to get back your capital, the only way for you is to sell them on the secondary market. The price you get might be lesser or more that what you paid for.

What then affects the market value of the preference shares?

Here, an understanding of bond pricing is required. Two things have the greatest effect on the pricing of bonds - interest rates and credit risk (A third factor is the accrued interest).

If the credit rating drops, the bond price might drop. This is straightforward.

If interest rates go up, bond prices will go down. And vice versa. To illustrate this concept, let’s look at a simplified example.

Suppose the risk free interest rate is 4% and you have a 2-year bond with a face value of $100 that pays a 4% coupon every year. In this case, your yield is 4%.

Assume the risk free interest rate increases to 6%. Nobody will want to buy your bond at $100 as he can get a better yield leaving his money in the bank. However, if a person can get a yield of close to 6% by buying from you at a reduced price, he might do so.

This price will be about $96. His returns over two years are $4 + $4 + $100 and his cost is $96. That works out (this is not the exact calculation) to be about 6.07% pa.

On the other hand, if the risk free interest rates drops to 2%, people will be more than willing to buy your bond for $100 to get the 4% coupon and yield.

In this case, the price will probably move closer to around $104. His returns over two years are $108 and his cost is $104. This works out to be about 1.9% pa.

For bonds, you can really get into trouble if interest rates spikes up. Imagine if the risk free rate is 20% pa. Your money will be stuck inside earning low yields with no possibility of liquidating it as the market value for the bond would be very low.

That more or less explains how the price of preference shares will be quoted on the secondary market. Very much like a bond price and not much to do with the price of the mother share (As there is no term to maturity, the calculation is slightly different from my earlier example). However, if the mother share collapses due to credit issues, the preference share price will be adversely affected.

This is also one additional thing. Because the preference shares can be redeemed at the option of OCBC after five years and on the occurence of certain events, it puts an artificial cap on the price it can attain. No one will want to pay too high a price for it since there is always a risk that it has to be sold back to OCBC at the face value.

That brings us to the last point. The redemption price.

If OCBC decides to redeem the preference shares (there are a few scenarios given in the prospectus that they can do so), they will have to pay the face value ($100) and any accrued dividends. The latter simply means the prorated amount of dividends owed to you. The market price it is trading at that time is irrelevant.

In the event of a liquidation and winding up of OCBC, bond holders get first priority, followed by owners of preference shares and then ordinary shareholders. If the liquidation assets are not sufficient to cover the obligations of the bonds and preference shares, you will get back less than the face value of your preference shares.

There has been considerable interest in the preference shares offered by OCBC, so I thought I’ll post some of the details here.

OCBC Preference Shares Offering

Price : S$100 per share

Total number of shares : 10 million

Value : S$1 billion

Dividend yield : fixed at 5.1% p.a.

Credit rating : Aa3 from Moody, A+ from Fitch and A- from S&P

Listed date (expected) : 30th July 2008

Subcription details:

Phase 1 (Placement)

9.5 million shares from 2nd June 2008 to 14th July 2008 to be placed via an application form (already fully subscribed).

Phase 2 (ATM offer)

0.5 million shares from 16th July 2008 to 28th July 2008.

Minimum subscription is 200 shares ($20,000). Thereafter in multiples of 100 shares ($10,000)

Frequently Asked Questions

1. Is the dividend of 5.1% guaranteed?

The payment of dividends on the preference shares is subject to declaration by our Board of Directors. As the preference shares rank ahead of ordinary shares, OCBC Bank would have to declare dividends on the preference shares if it declares dividends on the ordinary shares. Since the end of World War II, OCBC Bank has never stopped paying dividends on its ordinary shares.

2. Is the dividend of 5.1% calculated based on issue price of S$100?

The dividend of 5.1% per annum will be paid on a semi-annual basis, calculated on the issue price of S$100 per preference share. The dividend amount is not dependent on the prevailing market price of the preference shares.

For example, if you subscribe for 200 preference shares at S$20,000, the dividend payable to you on each dividend payment date will be approximately S$510 on 20 June and on 20 December of each year, which means a total amount of S$1,020 per year.

Please note that the first proposed dividend payment on 20 December 2008 will be less because of the shorter period for computation of dividend from 29 July 2008 to 19 December 2008.

3. Do I need to pay tax on the dividend received?

If you are a resident in Singapore, or if you are a corporate entity in Singapore, the dividend you receive will not be liable to any further Singapore tax as it is tax exempt. You will receive the 5.1% dividend without any tax deduction. If you are not a resident in Singapore, please seek your own tax advice.

4. What are the potential risks involved in this investment?

The key potential risks are summarised below:

• Dividend payment is not cumulative. If OCBC Bank for whatever reasons stops payment for one year, the amount not paid will not be payable in the following year(s)
• The Bank has the right but not the obligation to redeem the preference shares, and preference shareholders have no right to call for their redemption. Preference shareholders are however free to sell in the market
• The price of the preference shares may fluctuate depending on prevailing market conditions, including interest rates, as well as the credit standing of the Bank
• In an unlikely liquidation scenario, the preference shares will rank in priority to ordinary shares but junior to all depositors and other creditors (including holders of subordinated debt) of the Bank
• The market for the preference shares may not be sufficiently liquid or active. The preference shares may trade lower than the initial issue price

5. Will OCBC Bank redeem the preference shares? Will there be any change in the dividend rate in the future?

OCBC Bank may redeem the preference shares under the following circumstances, subject to, amongst other things, approval of the regulatory authority:

• on the date falling 5 years after the issue date, and on each dividend payment date thereafter, although the Bank is not obliged to do so. If the Bank should decide to redeem, it will pay the investor the issue price of S$100 for each preference share, plus any dividends payable up to the redemption date,
• if the preference dividend becomes subject to tax, due to changes in the Singapore tax laws, or
• if the preference shares do not qualify as capital of the Bank

If the Bank does not redeem, the dividend rate will stay at 5.1% and there will be no change in the dividend rate.

6. Will the preference shares be traded in the market?

Yes, you will be able to trade the preference shares once they are listed on the Main Board of the SGX-ST on or about 30 July 2008. Market price of the preference shares may be above or below the issue price.

For more details, you can download the press release and prospectus from OCBC.

OCBC Preference Shares Media Release

OCBC Preference Shares Prospectus

Please note that dates given above are subjected to change and can be bought forward depending on the demand. Investors who wish to find out more about the shares can visit any OCBC bank branch, visit their website at www.ocbc.com or call them at 1800-4386088.