What is a Callable Preferred Stock
A 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 preset price after a defined date. 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.
BREAKING DOWN Callable Preferred Stock
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.
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.
Redeeming Preferred Shares in Practice
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.