What Is a Preference Equity Redemption Cumulative Stock?
Preference Equity Redemption Cumulative Stock (PERCS) is a convertible preferred stock with an enhanced dividend that is limited in term and participation. Preference equity redemption cumulative stock shares can be converted for shares of common stock in the underlying company at maturity. If the underlying common shares are trading below the PERCS strike price, they will be exchanged at a rate of 1:1; but if the underlying common shares are trading above the PERCS strike price, common shares are exchanged only up to the value of the strike price.
Understanding Preference Equity Redemption Cumulative Stock (PERCS)
PERCS are essentially a form of a covered call option structure and are popular in an environment of declining yields because of the enhanced dividend. Upside profits are limited in order to produce a higher yield. PERCS can typically be redeemed before the maturity date, but at a premium to the cap price. Typically, if a holder of a PERCS does not redeem the shares within a three year period, the shares are automatically converted to common stock shares and the dividends are reverted to those ordinary dividends that would be paid on the common stock.
Each one of these non-traditional convertible securities has its own unique set of risk and reward characteristics. But, they all share the same basic features: an upside potential that is typically less than that of the underlying common stock, due to the fact that convertible buyers must pay a premium for the privilege of converting their shares; and they also enjoy higher than market (enhanced) dividend rates.
Example of Preference Equity Redemption Cumulative Stock (PERCS)
For example, if you own 10 PERCS on XYZ company with a strike price of $50, at maturity the following two outcomes could happen:
- If, at maturity, the underlying asset was trading at $40, you would receive a total of 10 common shares, worth $40 each.
- If, at maturity, the underlying asset had doubled and was now trading at $100, you would receive only five shares worth $100 each. The total value of the shares ($500) exchanged will equal the original strike price of $50 x 10 shares.
At the same time, say the dividend paid on common shares of XYZ is $1.00 per year. The PERCS shares might pay a dividend of $1.20 per year to their holders.