Definition of Preferred Equity Redemption Stock (PERC)
Preferred stock with special provisions limiting the value of its convertible shares and the mandatory redemption value at maturity.
Understanding Preferred Equity Redemption Stock (PERC)
PERCs generally offer a higher yield than common stocks. However, they can be called at any time, generally at a higher price than the cap price. When the PERC matures, it must be redeemed into either cash or underlying shares. PERCs can also be redeemed early by the issuing entity, however, this would be at a premium.
Originally introduced to investors in the early 1990s by Morgan Stanley, PERCs are considered to be equity derivative instruments, and they are generally classified as bifurcated securities because the return characteristics of the underlying security may be modified or divided among several other derivative securities.
PERCs come attached with agreed-upon terms involving mandatory conversions to preferred stocks. On the date of redemption, which typically occurs somewhere between three to five years after the date of issue, each PERC shareholder receives the following:
- If the existing common stock share price is lower than the price cap, the shareholder would be entitled to receive a single share of common stock for each share of preferred stock he or she holds.
- If the existing common stock share price is higher than the price cap, then the shareholder receives one share of common stock that is equal in value to the price cap for each share of preferred stock held. For instance, if the price cap is $50.00 and the current price of the common stock is $75.00, in this case, the preferred shareholder would receive $50.00/$75.00, or 0.66 shares of common stock, for each share of the preferred stock he or she holds.
A synthetic PERC offering is defined as a security that was designed to replicate its underlying mandatory conversion preferred stock. With synthetic PERCs, there is no involvement of the corporation to whose stock the product is linked. Instead, synthetic PERCS are essentially debt obligations on the originating company rather than equity of the company to whose shares they are tied. The coupon payment may be taxable as interest rather than as dividends. However, the basic features of the buy-write security are also available in synthetic PERCs.