By Julian Hofmann, 15 February 2012
Lloyds' preference shares rarely make the headlines for the right reasons after tumbling during the financial crisis of 2008, along with all other classes of bank debt. However, holders of the company's preference shares may be in line for some good cheer if, as is forecast, the bank resumes payments on some of its junior debt issues after an enforced stand-still on coupon payments by the European Commission runs out this year. That could prove to be a huge fillip for the securities, and for speculative investors, as at current prices Lloyds' range of prefs yield more than 10 per cent.
A note from Collins Stewart states that the next coupon date for the half yearly payment will be 31 May, which it expects to be honoured in full. There are about £300m Lloyds 9.25% prefs in issue and they carry a BB rating from Standard & Poor's, according to Collins Stewart, which also makes a market for the security. Furthermore, the broker reckons a dividend decision on the Lloyds' 6.475% prefs is imminent as the next coupon date is on 15 March, which could be the trigger for a major re-rating of all of Lloyds' outstanding securities.
However, as some commentators have noted, the re-rating of prefs (we can include permanent interest bearing shares in this) will depend on the attitude of major institutional investors. This group exited the bank prefs market in droves in 2009-10 and have not really returned with the kind of buying firepower that is needed to drive prices higher, particularly when many prefs have £50,000 minimum lots that puts them beyond the reach of the average private investor. Partly this is technical, many pension funds cannot buy securities with a low ratings and the credit downgrades handed to banks over the past three years has effectively ruled them out of the prefs market. Secondly, with the 50 per cent tax rate many higher rate income tax payers who may have the capital to buy prefs have opted instead to go for riskier capital growth, which is lower taxed, instead of income, which isn't.
Lastly, there is also the inadvertent value trap that can imprison your savings to consider, often triggered by events that do not relate to the basic health of a bank. For example, S&P's recent downgrade of some of Santander's hybrid securities were related to Spain's sovereign debt problems. Caution, therefore, might still be wise.
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