Preferred shares: the product Spanish banks sold as a fixed-term deposit

Preferred shares: the hybrid that banks sold as a fixed-term deposit

A customer walks into a branch and is offered a product with an attractive interest rate, no apparent risk, and the promise that, if they ever want their money back, the bank will find them a buyer. Years later, they discover that this "fixed-term deposit" is not a deposit, that they cannot cash it in whenever they want, and that, if nobody buys it, they are stuck with it. That, in practice, is what preferred shares are: a hybrid instrument between fixed and variable income that was massively marketed in Spain and has left thousands of investors feeling they bought something different from what they thought.

What exactly are preferred shares?

They are not shares, although they are sometimes confused with them. Nor are they a term deposit. Preferred shares are a perpetual security —with no maturity date— that pays a coupon usually linked to the Euribor and, unlike shares, carries no political rights: the holder does not vote at general meetings or influence the board of directors. The difference with cuotas participativas, another instrument that Spanish savings banks could issue, is that the latter actually work more like a share.

The coupon is not guaranteed. It is only paid if the issuer makes sufficient profit, and it can be suspended if its solvency so requires. In practice, most issues behaved for years like a fixed-income security: they paid periodic interest and investors reinvested it without a hitch. Until the time came to recover the principal.

The liquidity problem: selling is not the same as cashing in

Here lies the crux of the matter. Preferred shares cannot be cashed in like a fixed-term deposit. To get rid of them, you have to sell them on the secondary market, and that market, in many cases, is virtually non-existent. The bank may buy them back, but it is not obliged to. It can also place them with other customers, but if nobody wants them —because the coupon on offer is no longer attractive— the investor is left holding the security with no liquidity.

The comparison with the stock market is misleading. Selling shares in a large listed company is a matter of seconds; selling certain preferred shares can take days, weeks, or never happen at all. The key lies in the liquidity of each specific issue: some sell quickly, others remain buried in the portfolios of customers who bought them convinced they could exit whenever they wanted.

The coupon that stopped being a bargain

Many investors held them for years because the coupon was generous when rates fell. A recurring case: preferred shares linked to three-month Euribor with a guaranteed minimum of 4% APR and quarterly payments. With Euribor at rock bottom, that minimum turned the product into an excellent income stream. When rates rose, the coupon matched that of any term deposit and the appeal faded.

Other issues, however, were referenced to Euribor minus a spread, with no minimum. There, the investor assumes all the interest rate risk with no safety net. The perception of a "bargain" therefore depends on when it was bought and on what terms. The fine print —the part almost nobody read— is what decides whether the product was a good investment or a trap.

Real risk: neither deposit nor share

Preferred shares carry the risk of equities and the reward of fixed income. In other words, the investor can lose the principal if the issuer goes bankrupt, but does not share in the gains if the issuer does well. The coupon depends on the issuer's profit and solvency, not on an ironclad contract. And low liquidity adds a further problem: even if the issuer keeps paying, getting your money back can be mission impossible.

Some argue that, properly understood, preferred shares are not a bad product for portfolios seeking periodic income that can tolerate illiquidity. The opposing argument carries more weight: they were massively sold to retail customers who believed they were buying a fixed-term deposit, with neither the risk nor the absence of a maturity date explained to them. The line between a complex product and commercial deception depends on how it was sold, not just on how it was designed.

---

The story of preferred shares is that of a product that worked while rates cooperated and became a problem when the investor wanted out. With Euribor at low levels, some issues started to look attractive again. The unsettling fact is this: an instrument sold as the equivalent of a deposit can take weeks to find a buyer and, if none is found, there is no way to recover the money.