South Canterbury Finance Preference Shares

South Canterbury Finance (SCF) Preference Shares: A Summary South Canterbury Finance (SCF), a New Zealand finance company, issued preference shares as part of its capital structure. These preference shares offered investors a blend of features typically associated with both debt and equity. While SCF collapsed in 2010, resulting in significant losses for many investors, understanding the *intended* characteristics and risks of these preference shares remains important for historical context and understanding the dynamics of similar instruments. **Key Features (as advertised):** * **Fixed Dividend Rate:** A primary attraction was a fixed dividend rate, generally higher than prevailing interest rates on term deposits or bonds. This appealed to income-seeking investors, particularly retirees, looking for a reliable income stream. The fixed nature provided predictability, which was seen as a selling point. * **Priority over Ordinary Shares:** Preference shareholders were typically given priority over ordinary shareholders in the payment of dividends and in the distribution of assets in the event of liquidation. This meant that, *in theory*, preference shareholders were in a less risky position than ordinary shareholders. However, this priority offered little comfort when the company's assets were insufficient to cover all liabilities, including those owed to preference shareholders. * **Callable by the Issuer:** SCF retained the right to "call" or redeem the preference shares at a predetermined price, usually at par, after a certain date. This allowed SCF to retire the shares if market conditions changed or if alternative funding became more attractive. This feature presented a risk for investors, as they could be forced to reinvest their capital at potentially less favorable rates. * **Ranking in Liquidation:** Preference shares ranked ahead of ordinary shares in a liquidation scenario. However, they were typically subordinate to secured creditors, and sometimes also to certain unsecured creditors. This hierarchy meant that in a severe financial crisis, preference shareholders could still face substantial losses. **The Reality of SCF's Collapse:** Despite the advertised features, the reality of SCF's collapse revealed the inherent risks involved. When the company ran into financial difficulties, largely due to its exposure to the property market, it became clear that the assets were insufficient to meet all obligations. The government ultimately intervened with a bailout, but this was still not enough to prevent substantial losses for investors, including preference shareholders. The failure highlighted several crucial points: * **Credit Risk:** The creditworthiness of the issuer is paramount. A high dividend yield should have been a warning sign, indicating a higher level of risk. SCF's reliance on high-yielding, often speculative, investments to generate the income needed to pay the dividends made it inherently vulnerable. * **Liquidity Risk:** Preference shares, particularly those issued by smaller, less liquid companies, can be difficult to sell quickly if an investor needs to access their capital. This lack of liquidity adds to the overall risk profile. * **Misunderstanding of Risk:** Many investors may not have fully understood the risks associated with preference shares, especially those who were primarily focused on the fixed dividend income. The perception of security created by the term "preference" could have misled some investors into underestimating the potential for loss. In conclusion, SCF's preference shares, while offering the *promise* of a steady income stream and a degree of priority over ordinary shareholders, ultimately exposed investors to significant risk. The collapse of SCF serves as a stark reminder that even investments marketed as relatively safe can carry substantial downside potential, particularly when the issuer's financial health is compromised. Due diligence and a thorough understanding of the issuer's business model and financial position are essential before investing in any preference shares.