There was a flurry of excitement among retail investors on Monday when OCBC Bank launched its preference share offering, which is open to institutions and the man in the street.

The carrot: The shares came with an attractive 5.1 per cent fixed dividend rate, payable twice a year.

To qualify, you must have at least $20,000 which gives you 200 shares at $100 apiece, but you need not be an OCBC customer.

The red-hot demand resulted in an overwhelming response from retail investors who flocked to OCBC Bank branches on Monday and Tuesday. By then, the initial tranche was more than three times oversubscribed, so the bank stopped taking new applications.

OCBC's $1 billion offering came on the heels of DBS Bank's $1.5 billion preference share issue last month. In DBS Bank's case, the issue pays 5.75 per cent in the first 10 years and it is only available to institutions with a minimum size of $250,000.

Needless to say, this upset many small investors who felt that they were left out in the cold. DBS has since defended its 'prudent' action of preferring sophisticated investors in its issue. It explained that many investors do not fully understand the risks involved in purchasing such shares. For instance, a common misconception among investors is that preference shares are akin to fixed deposits.

Still, if you believe that you have missed the boat early last week and wish to have a bite of the cherry, you can have another go next month. The automated teller machine offer tranche for the OCBC preference shares is from July 16 to July 28.

Compared to the current low bank rates and the quiet stock market, the OCBC preference shares seem like a good deal. But they are not without risks.

Furthermore, not all retail investors are familiar with preference shares and their potential pitfalls.

What are preference shares?

As the term implies, preference shares come with certain rights that are ranked ahead of ordinary shares such as the payment of dividends. However, unlike ordinary stock, preference shares usually carry limited voting rights.

Preference shares are similar to bonds in that they have a par value and the holder typically receives a coupon or interest income.

But, unlike a bond which has a fixed maturity - where the principal sum is eventually returned to the bondholder - not all preference shares have a fixed maturity date.

It is up to the issuer to decide when they want to redeem the shares and sometimes, they can choose not to.

There are different types of preference shares. Some may be redeemable prior to maturity by the holder. Preference shares may also have a feature that allows them to be converted into ordinary shares.

In the case of both DBS' and OCBC's latest issues, they are 'non-cumulative', 'non-convertible perpetual' preference shares.

'Non-cumulative' means that if the bank does not make a dividend payout, it does not need to make up for it in the future when it is able to pay.

'Non-convertible' means the shares cannot be converted into ordinary shares. They are perpetual shares such as in the case of OCBC, which may decide not to redeem the shares even though it has the right to redeem it five years from the issue date and on each dividend payment date thereafter.

Are they comparable to fixed deposits?

No, preferences shares are different from fixed deposits because there may not be a fixed maturity date. This is because some preference shares are redeemable strictly at the discretion of the issuer. This means that the issuer may decide not to redeem them.

In contrast, the tenure of fixed deposits ranges from a month to a maximum of three years. Fixed deposits are also implicitly guaranteed by the Monetary Authority of Singapore (MAS) and are more liquid.

Why are these preferred shares issued?

For various reasons, including to raise funds for the issuer.

What are the advantages of owning these shares?

They offer an alternative to invest in an instrument with an attractive fixed dividend rate.

It is easy to see why retail investors, who are fed up with banks' current low interest rates, are attracted to OCBC's issue. Its dividend rate of 5.1 per cent is significantly higher than what most bank deposit products and bonds offer.

For example, a one-year fixed deposit offered by most banks will pay about 0.8 per cent. A 10-year Singapore Government bond will yield a return of about 3.3 per cent, and a 10-year HDB bond about 3.5 per cent.

Still, investors should understand that preference shares are not comparable with fixed deposits and bonds which carry lower risks.

For investors wishing to take more risks, there are other investment options. For instance, US dollar preference shares recently issued by some global banks were offering yields of around 7.5 per cent to 9 per cent, but those are US dollar instruments.

Is the dividend guaranteed?

The payment of dividend is subject to MAS rules, such as they cannot be paid if the issuer has insufficient distributable reserves due to accumulated losses or if, by paying shareholders, the bank is in danger of being insolvent.

In the case of OCBC, it said that since the end of World War II, it has never stopped paying dividends on its ordinary shares.

Is the dividend paid out taxable?

No, it is not taxable, unless you do not reside in Singapore.

Are they an alternative to the mother share?

No.

lorna@sph.com.sg