What Is Callable Preferred Stock?

Callable preferred stock is a type of preferred stock in which the issuer has the right to call in or redeem the stock at a pre-set price after a defined date. Callable preferred stock terms, such as the call price, the date after which it can be called, and the call premium (if any) are all defined in the prospectus. However, callable preferred share terms laid at the time of issuance cannot be changed later. 

Key Takeaways

  • Callable preferred stock is a variety of preferred shares that may be redeemed by the issuer at a set value before the maturity date.
  • Issuers use this type of preferred stock for financing purposes as they like the flexibility of being able to redeem it.
  • Investors enjoy the benefits of preferred shares, while also usually receiving a call premium to compensate for reinvestment risk if the shares are redeemed early.

Redeemable preferred stock, also known as callable preferred stock, is a popular means of financing for large companies, combining the elements of equity and debt financing. Redeemable preferred shares trade on many public stock exchanges. These preferred shares are redeemed at the discretion of the issuing company, where the stock is effectively bought back by the company. 

Callable preferred stock is routinely redeemed by corporations. This is done by sending a notice to shareholders detailing the date and conditions of the redemption. For example, on May 16, 2016, HSBC USA Inc. announced that it was redeeming its series F, G, and H floating-rate non-cumulative preferred stock, effective June 30. This means holders of the shares needed to return their shares on that day in exchange for payment of their capital, outstanding dividends and a premium, as the case may be.

Benefits of Callable Preferred Stock

Issuer Advantages 

A callable preferred stock issue offers the flexibility to lower the issuer's cost of capital if interest rates decline or if it can issue preferred stock later at a lower dividend rate. For example, a company that has issued callable preferred stock with a 7% dividend rate will likely redeem the issue if it can then offer new preferred shares carrying a 4% dividend rate. The proceeds from the new issue can be used to redeem the 7% shares, resulting in savings for the company.

Conversely, if interest rates rise after it issues the 7% preferred callable shares, the company will not redeem them and instead continue to pay the 7%. The company is protected from rising financing costs and market fluctuations.

Investor Advantages 

An investor owning a callable preferred stock has the benefits of a steady return. However, if the preferred issue is called by the issuer, the investor will most likely be faced with the prospect of reinvesting the proceeds at a lower dividend or interest rate.

To compensate for this, issuers usually pay a call premium at the redemption of the preferred issue, which compensates the investor for part of this reinvestment risk. Investors assure themselves of a guaranteed rate of return if markets drop, but they give up some of the upswing potential of common shares in exchange for greater security.

Callable vs. Retractable Preferred Shares

While callable shares may be redeemed by the issuer, retractable preferred shares are a specific type of preferred stock that lets the owner sell the share back to the issuer at a set price. Sometimes instead of cash, retractable preferred shares can be exchanged for common shares of the issuer. This may be referred to as a “soft” retraction compared with a “hard” retraction where cash is paid out to the shareholders.