Callable Preferred Stock

Callable Preferred Stock Definition

Callable preferred stock is the stock where the issuer of such stock enjoys the right to repurchase such issued stock after the pre-decided date at a specific price mentioned in the terms of prospectus while issuing stock and such price cannot be changed later at any time or at the time of redemption.

In simple terms, callable Preferred Stock is a type of preferred stock that gives the issuer the right to call or redeem the stock at a pre-set price after a pre-determined date. Also known as callable preferred shares, it is a popular means for financing large-scale organizations as it uses a combination of debt and equity financing. Such shares may also be traded on the stock markets as well.

Callable Preferred Stock

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How Callable Preferred Stock Works?

Company ‘R’ issued preferred stock in 2005, paying 12% rate and maturing in 2025 and also callable in 2015 at 103% of par value. Ten years from the issue, ‘R’ gains the right to call the stock, which it may consider if the interest rates in 2015 fall below 12%.

Generally, the issuer must pay the investor more than the par value of the stockPar Value Of The StockPar value of shares is the minimum share value determined by the company issuing such shares to the public. Companies will not sell such shares to the public for less than the decided value.read more for calling the issue. This difference is termed as ‘Call Premium,’ and this amount typically decreases as the preferred stock is coming close to maturity. Say Company ‘R’ will offer the stock at 103% of face value if the call was issued in 2015, but it may offer only 102% if called in 2020.

Features of Callable Preferred Stock

There are some important features of such stocks:

Benefits

Drawbacks

  • Investors may be unwilling to pay as much as equity subject to call.
  • The perceived value of the callable preferred stock is unlikely to be higher since they have less potential for the upswing. Therefore, investors who are anticipating a bullish market/stock must cash in on such shares before the issuer announces a call. A call announcement generally plummets the share value towards the par value. It sends a signal that there could be some issues in the management, and such a step is required to be taken.
  • Another angle highlights the ‘call price premiums’ which guarantee a return even if the market is underperforming. It may be a costly option, but investors should consider such options if their investment objective involves consistent returns.
  • The addition of security classes can complicate the corporate structure, which further imposes compliance costs. It can further expose loopholes in the funding structure. Dividends to the common shareholders will not be considered unless preferred shareholder dividends are paid in complete. Callable preferred stock can generally be a problem if you offer high dividend rates for preferred stock shareholders.
  • If the call price turns out to be lower than the existing market price, the investor loses part or entire capital gains if the firm decides to call the shares.

Conclusion

The option of a callable preferred stock shall be considered if the organization is currently exploring financing options for a new unit/firm and desire to avoid the complexities in equity and debt financing. Though the procedure of repurchasing the shares is easy as the conditions are laid down during inception, and only notice must be sent to the relevant shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more with essential details. However, since premium has to be offered at the time of the call, issuers must ensure they have sufficient cash balance with them, which could be at the cost of other opportunities to the firm. Such a step also has an impact on the share price and put a cap on the same. Thus, all these aspects must be considered before arriving at any decision.

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