Callable Preferred Stock

Callable Preferred Stock may be repurchased by the issuer as of a certain date for a certain price. The call generally happens only if interest rates drop. When interest rates go down, the issuer might get tired of paying generous 6% dividends every year. If so, they can buy the preferred stock back and retire the shares. Or replace them with new preferred stock paying lower dividends that reflect the new lower interest rate environment.

Callable preferred stock tends to pay the nicest rate of return. Most types of preferred stock have no maturity date and are, therefore "perpetual". That's why callable preferred stock is unique. Since this type of preferred stock is callable, it can be repurchased and retired by the issuer instead of paying out preferred dividends indefinitely.

Most preferred stock

Most preferred stock is callable preferred stock- that is, the issuing corporation can redeem or retire it at a price stated in the preferred stock contract. An owner of nonconvertible preferred stock must surrender it to the issuing corporation when asked to do so. If the preferred stock is convertible, the stockholder can either surrender the stock to the corporation or convert it to common stock when the corporation calls the stock. The call price, or redemption price, is usually higher than the stock's par value. For example, preferred stock that has a $100 par value might be callable at $103 per share.

When preferred stock is called and surrendered, the stockholder is entitled to the following:

• the par value of the stock
• the call premium
• any dividends in arrears
• the current period's dividend prorated by the proportion of the year to the call date

Redeemable Preferred Stock

In contrast to convertible preferred stock and callable preferred stock, some preferred stock is redeemable. Redeemable preferred stock either may be subject to mandatory redemption at a specified future maturity date for a specified price, or redeemable at the option of the holder (instead of being callable at the option of the issuer).

Redeemable preferred stock has a key characteristic of a liability because of the likelihood of a cash outflow in the future that the company has no ability to prevent. Therefore, a corporation with mandatory redeemable preferred stock is required to report the preferred stock as a liability. If both the maturity date and redemption price are fixed, at the end of each year the corporation reports the liability at the present value of the amount to be paid at settlement.

To determine the present value, the corporation uses the implicit interest rate when it issued the redeemable preferred stock.It records interest expense for the change in the present value during the year. If either the maturity date or the redemption price is not known, at the end of each year the corporation reports the liability at its current market value.

Examples of Callable Preferred Stock

• AT&T 6.125% Series A Preferred Stock: AT&T’s 6.125% Series A Preferred Stock is a callable preferred stock issued by AT&T Inc. The stock was issued in December of 2016 and can be called at any time after five years from the issue date at a redemption price of $25 per share. The stock pays an annual dividend of 6.125% and is traded on the New York Stock Exchange under the ticker symbol T.
• Wells Fargo 5.85% Non-Cumulative Perpetual Preferred Stock: Wells Fargo’s 5.85% Non-Cumulative Perpetual Preferred Stock is a callable preferred stock issued by Wells Fargo & Company. The stock was issued in August of 2016 and can be called at any time after five years from the issue date at a redemption price of $25 per share. The stock pays an annual dividend of 5.85% and is traded on the New York Stock Exchange under the ticker symbol WFC.
• Bank of America 5.75% Non-Cumulative Perpetual Preferred Stock: Bank of America’s 5.75% Non-Cumulative Perpetual Preferred Stock is a callable preferred stock issued by Bank of America Corporation. The stock was issued in August of 2016 and can be called at any time after five years from the issue date at a redemption price of $25 per share. The stock pays an annual dividend of 5.75% and is traded on the New York Stock Exchange under the ticker symbol BAC.

Advantages of Callable Preferred Stock

The advantages of Callable Preferred Stock include:

• Increased Return on Investment – Investors typically receive a higher rate of return than with non-callable preferred stock, as the issuer is willing to pay a premium for the option to call the preferred shares.
• Flexibility - Callable Preferred Stock gives the issuer the flexibility to either retire or replace the preferred stock when interest rates change.
• Lower Dividend Rate – If interest rates go down, the issuer can buy back the preferred stock and replace it with new preferred stock that pays a lower dividend rate commensurate with the new lower interest rate environment.
• More Control – Callable preferred stock gives the issuer more control over the amount of capital they are able to raise by allowing them to call the preferred stock at a predetermined price and date.

Limitations of Callable Preferred Stock

Callable Preferred Stock has certain limitations that investors should be aware of. These include:

• Potential for loss of dividends: When preferred stock is called, the investor may lose out on any dividends that have accrued but not yet been paid.
• Potential for capital loss: The issuer may call the preferred stock at a price lower than the original issue price, resulting in a capital loss for the investor.
• Limited liquidity: Callable preferred stock may not be easily traded on the secondary market due to its limited availability.
• Interest rate risk: Interest rate changes can cause the issuer to exercise the call feature, resulting in a loss of income for the investor.
• Lack of control: Callable preferred stock gives the issuer control over when the stock will be called, leaving the investor with limited ability to influence the decision.

Other approaches related to Callable Preferred Stock

A callable preferred stock can be used by issuers in a number of ways:

• Issuers may use callable preferred stock to reduce their dividend payments over time. When interest rates decline, the issuer may call the stock and replace it with new preferred stock that pays a lower dividend rate, thus reducing their costs.
• Issuers may use callable preferred stock to raise capital. By calling the preferred stock, the issuer can quickly raise capital to fund new investments or other projects.
• Callable preferred stock may be used as a hedge against rising interest rates. If interest rates rise, the issuer may call the preferred stock before the higher rates take effect, thus protecting their profits.

In summary, callable preferred stock offers issuers a variety of options to reduce costs, raise capital, or hedge against fluctuating interest rates.

Footnotes

Callable Preferred Stock — recommended articles

Cumulative Preferred Stock — Mezzanine capital — Authorized Stock — Bonds in finance — Bunny Bond — Property Dividend — Held to maturity securities — Hybrid instrument — Redeemable shares

References

• Needles B.E., Powers M., (2010), Principles of Accounting, Cengage Learning, Mexico.
• Nikolai L.A., Bazley J.D., (2010), Intermediate Accounting, Cengage Learning, Australia.
• Walker R.M., (2010), A Training Guide, First Books, Oregon.

Author: Sylwia Jurkowska