What Is Callable Preferred Stock?
The terms of a callable preferred stock issue, 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 at the time of issue and cannot be changed later. As with regular preferred shares, dividends on callable preferred shares must be paid by the issuer ahead of any dividends on its common shares.
- Callable preferred stock is a variety of preferred shares that may be redeemed by the issuer at a set value and maturity date.
- Issuers like the flexibility of calling in this type of preferred share for its financing purposes.
- Investors enjoy the benefits of preferred shares and a call premium to compensate for reinvestment risk if the shares are redeemed early.
How Callable Preferred Stock Works
Callable preferred stock, also known as redeemable preferred stock or callable preferred shares, is a popular means of financing for large companies, since it combines elements of equity and debt financing. Many callable preferred shares trade on public stock markets.
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 that 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.
Advantages for Issuers of Callable Preferred Stock
A callable preferred stock issue is advantageous to the issuer, since it confers 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 is quite likely to call the issue if it can issue new preferred shares carrying a 4% dividend rate. The proceeds from the new issue can be used to redeem the 7% shares, resulting in a direct savings of 3% for the company.
Conversely, if dividend rates on the market go up, the company will not call the shares and will continue to pay only 7%. The company is protected from rising financing costs and market fluctuations.
Advantages for Investors
The investor who holds callable preferred shares, on the other hand, has assured himself of a steady return. 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.
However, to compensate for this, issuers usually pay a call premium at 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.