The ability of a portfolio to generate stable returns can be vital. Too much focus on seeking stocks whose price is supposed to rise often means that the option of using preference shares to underpin a projected annual return of, say, 10 per cent is overlooked. Demand for preference shares has revived since the lows of the banking crisis, yet investors should look again at this asset class as a stable form of income. Preference shares issued by Lloyds Banking and the old Bristol & West Building Society look especially good value.
- Prefs help underpin portfolio performance
- Good levels of income yield
- Legal issues have been clarified
- Banking system still weak
- Bristol & West could face loan recall
Lloyds may still be mired in arguments over payment protection insurance, but at least it can pay dividends again on its varying classes of equity/debt hybrids. The Lloyds Banking 6.475 per cent preference share found its way into the Lloyds capital structure from the deal to takeover HBOS. Originally an issue by Halifax Building Society, this preference share is highly liquid, and it's mostly owned by investors with an average of just 400 shares. The shares have a 'call' date of 2024 and analysts at broker Canaccord Genuity believe there is a good chance that the shares will be bought in by then because of the expense of maintaining such a large shareholder list.
Lloyds' administration problems will earn little sympathy, but the possibility that the shares will be called at 100p means the current price of 92p offers the potential of a 'redemption' yield of almost 7.6 per cent (ie, after adding the annualised capital gain to the income). Given the difficulty of finding acceptable levels of income, that looks like a good deal. The bear points relate mainly to the low rating the prefs get from the ratings agencies. That reflects the fragility of the banking system, which is still some way from operating "normally", but it is difficult to see what relevance this has for the prefs so long as the dividends are paid.
| ASSET | PRICE | COUPON | RUNNING YIELD | TICKER | ISIN NUMBER |
| Bristol & West Preference shares | 107.5p | 8.13% | 7.56% | BWSA | GB0000510205 |
| Lloyds Bank Preference shares callable 2024 | 92p | 6.48% | 7.04% | LLPE | GB00B3KSB568 |
Normality is something that Bristol & West (B&W) preference shareholders had to fight hard to achieve after a legal battle with Bank of Ireland. The Irish bank, which inherited the prefs when it bought B&W, tried to impose a haircut on holders at the height of the credit crisis. That effort was unsuccessful and the prefs have now recovered from their low price below 40p to trade at 107.5p. However, it is the security of the payout that will most concern potential holders. In 2010, Bank of Ireland made a £70m interest-free 'loan' to B&W, the interest from which covers the cost of the preference dividends, which was £2.6m in 2011. The loan has no fixed term, but is repayable to Bank of Ireland on demand.
The fact that the loan can be recalled at any time ties the fortunes of B&W prefs holders to the financial success of the Irish parent. Happily, there are signs that Bank of Ireland's funding arrangements are easing. Although it still depends heavily on Irish government support, it was able to access the bond markets recently with a successful €500m (£430m) auction of covered bonds. That, combined with what looks like a decent recovery in Ireland's export markets, means that the loan won't be recalled imminently and, even if it were, it's quite likely that the Irish bank would still have an obligation to see that the preference dividends are paid.
