The potential for Aviva to cancel £450m worth of preference shares has been branded an example of “buyer beware” to investors who choose stock picking.
In its results statement last week, Aviva revealed it legally can cancel nearly half a billion pounds worth of preference shares held by investors.
Jason Hollands, managing director for business development and communications at wealth manager Tilney, said the move should come as a warning to investors.
"This is a salutary reminder of the of the principle of caveat emptor (buyer beware) for investors who dabble in individual securities rather than collective investments.
"It is important to be aware of where the security ranks in the overall capital structure and the rights an issuer has to buy back the security.”
The terms under which the preference shares were issued in the early 1990s allowed Aviva to buy them back at par value.
Preference shares work like bonds, though are counted as equity, because they pay a fixed income every year, whereas a dividend payment can vary.
The preference shares yield between 8-9 per cent, and trade at a price higher than the par value at which Aviva is considering buying them back. This is because the yield investors receive from their preference shares, at least 8 per cent, is much higher than the yield offered on comparable products in the market.
So investors are willing to pay more than the face value of the bond, and take a slightly lower yield, say 7 per cent, because that yield is still higher than that available on a comparable product.
Aviva could borrow the money, or use its own cash reserves, to buy back the shares, as all other sources of finance open to it would cost less than 8 per cent a year.
The company said its responsibility is to consider the interests of both ordinary shareholders, who receive a dividend of around 5 per cent, and the preference shareholders, receiving 8 per cent.
Aviva’s view is that it could save about £40m a year by cancelling the preference shares, with this money then available to be part of the dividend paid out to the holders of the ordinary shares.
Aviva is entitled to make the change if a majority of the shareholders vote for it.
The market cap of Aviva is over £20bn, while the preference shares are worth about £450m. Cancelling the preference shares and using the cash saved to increase the dividends on the ordinary shares would be in the interest of the ordinary shareholders, and as there are significantly more of those than there are preference shareholders, it is likely the wishes of the ordinary shareholders would win out.
Aviva has emphasised no final decision has been taken. The company has £3bn of surplus capital and will look to distribute about £2bn of it in the coming years.
Buying back and cancelling the preference shares is just one of the options being considered by the company as a way to use the capital.