Understanding Preferred Shares

Preferred shares are often misunderstood, overlooked, or mistaken for something they’re not.

Sitting between interest-bearing bonds and dividend-paying common shares, these offer a blend of steady income and equity characteristics.

These can provide regular cash flow, accessibility, and relative price stability. But like any asset, they come with nuances—and risks—that investors should fully understand.

Preferred shares are a class of equity issued by companies to raise capital, much like common shares or bonds. But these sit somewhere in the middle of the risk-return spectrum. Think of it this way:

• Common shares provide ownership and voting rights, but dividends are not guaranteed.
• Bonds are debt, with fixed interest payments that companies must pay or risk default.
• Preferred shares offer the income stability of bonds and the ownership features of equity, but without voting rights in most cases.

Preferred shares are an option for investors who like the predictable income that bonds offer, while generally offering lower volatility than common stocks. Preferred shares typically offer:

• Fixed dividends, often cumulative and at a higher rate than comparable common stocks and bonds
• Favorable tax treatment—10% Final Withholding Tax for Resident Individuals and 0% for
• Domestic and Resident Foreign corporations (per the National Internal Revenue Code of 1997, as amended) —compared to bonds
• Priority over common shareholders in dividends and liquidation
• Less volatility because returns are predetermined
• Lower minimum investment sizes and less documentation compared to bonds
   

Many invest in preferred shares because of their fixed dividend rate. While preferred share prices are less volatile, the fixed nature of returns may also limit price upside compared to common. This makes preferred shares attractive for investors seeking steady income rather than capital gains.

However, here’s an important point: Preferred share dividends are not guaranteed, even though the rate and payment schedule are fixed. Under Philippine corporate law, dividends—whether for common or preferred shares—can only be paid if the company has sufficient Unrestricted Retained Earnings (URE). If the URE is inadequate, dividends may be suspended.

To compensate for this risk in periods of weak corporate earnings, many Philippine preferred shares are cumulative. This means that (1) skipped dividends accumulate, and (2) must eventually be paid before any dividends can be issued to common shareholders. Still, unlike with bonds, missed dividends do not constitute a default.

It’s easy to confuse preferred shares with bonds because both provide regular income. But legally and economically, preferred shares are equity, not debt.

Here are the practical differences:

• Bond payments are obligations; the company must pay interest and principal on time.
• Preferred dividends are discretionary, depending on profitability and subject to provision of Unrestricted Retained Earnings.
• Bondholders are creditors (lenders); preferred shareholders are part-owners.
• In liquidation, bondholders get paid first, then preferred shareholders, and last are common shareholders.

This makes preferred shares inherently riskier than bonds – yet typically higher yielding.

Most preferred shares do not grant voting rights, meaning investors cannot vote for the company’s directors or have a say in management decisions. This allows companies to raise capital without diluting control.

Preferred shareholders typically gain voting rights only when decisions directly affect their class, such as changes to dividend structures or rights of their preferred series.

How long do preferred shares last?
Many preferred shares in the Philippines are issued as Perpetual, meaning they have no maturity date. They remain outstanding unless redeemed (or called) by the issuer.

Issuers often call preferred shares when:

• A pre-defined “step-up” rate kicks in (making future dividends expensive)
• Market interest rates fall
• They can refinance at a lower cost
• They want to reassure investors by demonstrating strong liquidity

Keep in mind that redemption is never mandatory. Investors should be comfortable holding the securities indefinitely, or sell their shares back through the stock market for liquidity.

Like any investment, preferred shares come with risks:

1. Dividend suspension. When a company’s profits fall, it may cause delays or non-payment.
2. Lower priority in case of trouble. If liquidation happens, bondholders get paid first.
3. Market price stability may be a detriment if investors are after capital appreciation.
4. Non-Call risk. Issuers may opt to have a call date lapse, potentially affecting investor’s capital availability.
5. Liquidity risk. Some preferred shares may trade lightly, making buying or selling harder or price wider.

Preferred shares can be a valuable component of a diversified portfolio for investors seeking regular income with relatively lower volatility. They are particularly well suited for long-term, cash-flow-oriented investors —especially those who benefit from favorable tax treatment—provided they recognize that dividends are not guaranteed, carry their own risks, and remain subject to the same market forces affecting both common shares and bonds.

Clients can gain exposure to this asset class either actively through a Directional Trust or the First Metro Securities Brokerage platform, or passively through the Metro Unit Paying Fund and Metro High Dividend Yield UITFs.

DANIEL ANDREW TAN is an Investment Counselor at Metrobank’s Institutional Investor Coverage Division. He leverages his extensive background in retail banking and wealth management to deliver strategic investment advice and bespoke portfolio solutions to clients and stakeholders. He focuses on delivering timely and relevant advice to help navigate shifting financial landscapes with confidence. Outside of work, he stays up-to-date on economic and political developments via podcasts and other alternative media.