Callable Preferred Stock | Push Digits Chartered Accountants

Callable Preferred Stock

 

Callable Preferred Stock

This preferred stock allows the issuer to repurchase the stock before its maturity at a stated price known as the call price. This call feature is included in the preferred stock indenture.

In other words, callable preferred stock is a type of stock in which the issuer has the option to redeem or call in the stock at a pre-agreed price after a set date.  The terms and conditions of a callable preferred stock such as the time period after which the stock can be redeemed or called, call price, and call premium are all defined and explained in the prospectus. However, terms of a callable preferred share laid down at the time of its issuance cannot be altered or changed later. Preferred stock with the option to call is also known as redeemable preferred stock. It is a popular means used by corporations for financing purposes. Callable preferred stock trade on many public stock exchanges. These types of shares are called or redeemed at the discretion of the entity issuing them.

Callable preferred shares are redeemed by corporations by formally notifying their shareholders about the conditions and time of the redemption.

Benefits of a Callable Preferred Share

First, we will discuss the benefits associated with a callable preferred share from the perspective of the entity issuing such an equity instrument.

A callable preferred share offers its issuer the opportunity to lower its cost of capital in case interest rates available in markets decline or if it can issue a preferred share with a lower dividend rate. For example, a corporation issues some callable preferred shares having a dividend rate of 6%. The company is likely to redeem the aforementioned shares in case interest rates decline and it could issue new preferred stock having a dividend rate which is less than 6%. The company can use the proceeds received against issuing the new stock to redeem the 6% stock, resulting in the company reducing its cost of capital.

On the flip side, if interest rates rise after the company issues 6% stock, then the company may decide to not redeem the said shares and instead continue paying the 6% dividend rate. In short, a callable preferred share provides its issuer protection against market fluctuations and rising finance costs.

Let’s discuss the benefits of a preferred stock having the feature to call from the perspective of an investor.

The major benefit which an entity holding callable preferred stock enjoys is a steady return. However, if a preferred share is called by its issuer then the investor will most likely to be exposed to the risk of reinvesting at lower interest rate or dividend rate.

In order to compensate the investor against the risk of re-investment, the issuers are usually required to pay a call premium at the time of the redemption of the preferred stock.

Retractable and Callable Preferred Shares

While callable preferred stock provides the issuer with the option to redeem the stock by compensating the investors in the form of call premium, retractable preferred stock is a type of stock that lets the holder sell the stock back to the issuing entity at a set price. In some cases, investors instead of receiving cash prefer exchanging retractable shares for common shares of the issuing entity.

 

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