I GOT a number of emails thanking me for the insightful Cai Jin column on preference shares which was published yesterday.
One reader wrote to say that she liked the explanation on why DBS Bank was able to offer such a generous dividend payout for the preference shares, even though it was getting a far lower interest margin for its loan.
This was a question which some investors had been asking themselves, even as they avidly subscribed to the offering.
While DBS Bank’s impressive pedigree and proven track record are big draws, I am not surprised if they find themselves wondering if there was any catch where the attractive dividend yield was concerned.
With the fiasco involving Lehman minibonds still fresh on their minds, who can blame them for wanting to err on the side of caution ?
So while they want to get a higher yield on their hard-earned money, they are also wary that their investments may go up in smoke if they are not careful.
Anyway, I find explaining the exercise explaining the dividend yield on the DBS preference shares a useful one.
In recent years, the financial media has been polluted by so much jargon like Basel II, Basel III, capital adequacy ratios, Tier-One capital and so on, that the poor reader might as well be reading Greek when he opens up the financial pages of a newspaper.
But Basel II, Basel III, capital adequacy ratios and Tier-One are simply short-hand jargon used by bankers to describe the amount of money which a lender must set aside as back-up capital to compensate depositors for any bad loans which they have made. It is as simple as that.
As I explained in my Cai Jin column, there is nothing mysterious about the generous yield offered on the preference shares, without having to resort to the complicated terminology described above. The generous payout is to compensate the holders of such investments for any upside they might have missed, if they have bought the bank shares instead, if it outperforms.
For me, the best part of the exercise is being able to explain it simply by using an example.
I think the explanation offers some assurance to investors as to what they are getting into.
So long as DBS continues to lend prudently and keep any bad debts to a minimum, there is no reason why the 30,000-odd successful applicants of the preference shares will not get their payout.
If investors put their heart to it, they will find that the idea behind many investment products is very simple, stripped of all the financial jargon that makes them sound very complicated.
Take the Lehman minibonds which I cited earlier.
I have always wondered if the fallout would have been less severe, if it had been listed on the Singapore Exchange, and not sold over-the-counter by financial advisers at a bank. This is because of the intense scrutiny which dealers, analysts and market writers usually subject new offerings to.
Explaining the minibond in simple terms would have made it clear immediately to investors that they are not buying into a corporate bond, but a bundle of CDOs which had been assembled by Lehman Brothers.
Now if you know that the Lehman minibonds’ CDOs were actually made up of different tranches of bonds – some of dubious origins – which had been assembled from all over the place, rather than the plain vanilla debt offered by a triple-A rated bank, would you have touched it in the first place?
I would think not.