The cataclysm at Britain's failed banks has devastated one of the principal sources of dividend yields, and now even BP, which provides a seventh of all FTSE 100 income, has been forced to cut its dividend. However, all is not lost for those prepared to widen their income-seeking horizon. Preference shares provide an extra cushion to protect income over ordinary shares and a recent fall in prices is giving some a tasty yield.
"There has been a recent fall in [preference share] prices in response to the eurozone crisis, which means some good yields are to be found," says professional bond investor Mark Taber, who runs a website for retail investors at fixedincomeinvestments.org.uk.
Because they are a hybrid of ordinary shares and debt, preference shares' prices have been hit recently by worries that affect the debt market, as well as concerns over corporate profitability and solvency. Yields on many of the more liquid issues now sit firmly in the 7-9 per cent range, with a few of the more obscure ones higher.
There have been some major changes in the preferred share market in the past year, with the ranks of Lloyds Banking Group issues being thinned considerably by an exchange offer that saw many issues replaced by contingently convertible (CoCo) issues.
The remaining issues have a kind of jumble sale feel to them. There are more than 85 preference shares listed in London, including tiny issues such as the £11,640 outstanding of Stewart & Wright 6 per cent 33 1/3p, right up to the £300m of Lloyds 9 per cent. For many smaller issues prices barely change and the thin market means that spreads are very wide. Even a casual glance will reveal that preference shares are still traded in many companies that were long subsumed into larger entities. Bristol & West, which has an 81/8 per cent coupon non-cumulative issue, is now part of Bank of Ireland. General Accident, part of Aviva, is there too, as is RSA Assurance, the former Royal & Sun Alliance and Northern Electric, which is owned by Mid-American Energy Holdings.
Should we care who owns these companies? Absolutely. It is an essential part of deciding what the risk-reward trade-off is for a particular issue. Preference shares were, like permanent interest-bearing shares (Pibs), never as safe as we used to think they were. That realisation came courtesy of the banking crisis, although of course those risks were always present. More than ever, we have to be sure that principal and interest are safe, or at least that we are being adequately rewarded for any risk of non-payment. We may be more worried now about company solvency, but that awareness actually makes us more safe.
So, on that basis, the attractions of Northern Electric may be enhanced once we realise that MidAmerican Energy Holdings is owned by Warren Buffett's Berkshire Hathaway, where cash and fidelity to bondholders are held in high esteem. After all, it was Mr Buffett who insisted on being paid in preference shares when he invested $5bn into Goldman Sachs in 2008.
"In terms of the better quality 'must-pay' preference shares, the 9 per cent NatWest issue (NWBD) and 8.75 per cent Aviva issue (AV.A) both yield over 8 per cent," says Mr Taber.
There is, however, a much wider universe of preference shares for those who are either prepared to look at non-sterling-denominated issues, or to speculate on the future value of issues where coupons are suspended.
"There is a 'must pay' USD NatWest preference share (NW-C) which is yielding over 10 per cent and looks good value if you are happy with the currency risk," Mr Taber says.
"The prices of the preference shares affected by two-year EC coupon deferral have come back the most recently and the perpetual 9.25 per cent and 9.75 per cent Lloyds preference shares are both available on income yields approaching 12 per cent," says Mr Taber. "This looks good value considering Lloyds cannot start paying ordinary dividends until they are paying on these again."
These preference stocks are the rump of those where owners did not tender in the recent Lloyds debt swap, or were because of settlement issues not able to hold the enhanced capital notes offered in exchange. They are not currently paying a coupon due to a European Commission ruling that shareholders (including preference shareholders) should not get dividends before state aid is repaid.
