Dbs Bank - Reasons for Issuance of Preference Shares

1. Introduction

Recently, Singapore's largest bank, DBS, has taken the wraps off a $500 million preference share issue that qualifies for Tier 1 capital to retail investors. This is in spite of over-subscription from institutions. DBS has offered to pay 4.7% dividends on a semi-annual basis for this preference share which beats the meagre 0.125% interest offered on bank savings accounts. These preference shares are non-convertible, non-voting and unlike general preference shares, they are non-cumulative. The biggest attraction is the bank's proven track record leading to overwhelming demand from retail investors. This prompted DBS to increase its total offer size to $800 million from $500 million.

2. Reasons for Issuance of Preference Shares

2.1 Real Situation

The reason for DBS's issuance of this preference share is to replace $2.2 billion worth of Tier 1 instruments issued in 2001 that can be redeemed next year. The proceeds from the offering will also be used to strengthen the bank's capital base and support its growth initiatives.

2.1 Signalling Effect

In the company's perspective, when managers predict unfavourable future prospects, i.e. stock is overvalued; the firm will issue more stocks to split the losses with new shareholders. Moreover, there will be doubts from investors whether the issuance of preference shares is an alternative to raise capital (i.e. DBS is lacking capital). As such, investors who do not closely follow DBS may regard the share offering negatively and the problem of asymmetric information might arise, leading to negative responses. However this was adequately addressed by DBS, contributing to the overwhelming demand.

3. Risks

In September 2008, Fannie Mae and Freddie Mac, two giant real estate lenders in the United States were forced into 'conservatorship' , rendering billions of dollars in preference shares worthless overnight. This reiterates the fact that risks are still inherent in preference shares.

3.1 Unguaranteed Dividends

Preference shares dividends are generally non-guaranteed. According to the DBS offer document, it has the right to suspend dividends should its financial condition deteriorate and investors would not receive dividends. The example of the US crisis has proven that though DBS is well-known for its discreet business practices, it is important not to take such assurance for granted.

Moreover, unlike general preference shares, DBS's are non-cumulative. Dividends which are not paid in a financial year will not be accumulated and carried forward. Retail investors face the prospect of not receiving any dividend in the