A Year of Retail Bonds and Preference Shares

It's 1 Jan 2012, and morphing shortly to the Year of the Dragon.

News seem to suggest that there will be a sprinkling of companies raising funds through Retail Bonds and perhaps Preference Shares.  Chances are good as credits are likely to be tight.  So this is one avenue for companies to secure credit.  Hopefully, these will be priced at more exciting levels, offering above 4% annual pay out?

I keep seeing comparisons that people make between the yield of REITs, comparing against bond coupon rates, and similarly, preference shares.  However, there is a big difference involved concerning the principal amount.  In the case of REITs, the yield is dependent on the current stock value of the REIT, so it will fluctuate.  In contrast, the coupon and dividend payment of bonds and preference shares are based on the original face value (or par value) and is not dependent on the trading value of the bond/preference-shares.

To illustrate, if the REIT was priced at $1.00 per share, a 5% dividend  would give $0.05 per share.  In the following year, if the REIT collapses to $0.50 per share, a 5% dividend would give only $0.025 per share.  For the REIT to continue giving out the same amount of $0.05 per share, it would have to pay out a dividend of 10%.  Whether the later is possible depends on its business revenue generated.

In contrast, a bond would be priced at $1.00 per unit.  If it has a 5% coupon payout, one gets $0.05 per unit every year until maturity, where the bond is then redeemed by the issuer at the original capital of $1.00 per unit.  The coupon payout does not fluctuate.  On the secondary trading market, the bond would be trading at values, and that does fluctuate.  But that does not affect the coupon payout.  It only has an impact if one needs to sell it off before maturity.

It is similar for preference shares.  For non-cumulative preference shares, the difference would be that there may be no payout if the underlying stock does not as well.  So it's important that such companies are well managed and have a consistent history of always paying out.  In the case of cumulative preference shares, any payout missed in one year gets carried over to the next - i.e. cumulative.  Some of the preference shares are "perpetual", and may never be redeemed.
[SGX List of Preference Shares]

The Toto special for New Year is estimated at $3 million.  If one was to win this sum, and invest the winnings in a series of bonds and preference shares (diversification!) that gives an average of 4% coupon/dividends, that's $120,000 per year perpetually!  Not bad. 

One can dream.  Buy a ticket today for that HOPE - a four letter word. 

Disclaimer: Winning is not guaranteed. *grin*  Happy New Year 2012!