Callable Preferred Stock

by / ⠀ / March 11, 2024

Definition

Callable Preferred Stock is a type of preferred stock in which the issuing company has the right to redeem or ‘call’ the stock at a pre-set price after a specific date. This gives the company flexibility to reduce its cost of capital if interest rates decline or if it can issue new preferred stock at a lower dividend rate. The call feature presents a risk to shareholders as they may have their shares called and be forced to reinvest the proceeds at a lower return.

Key Takeaways

  1. Callable Preferred Stock refers to a type of preferred stock in which the issuer has the right, but not the obligation, to recall and retire the stocks at a certain price after a particular date.
  2. The main advantage of this type of stock to the issuing company is the ability to reduce their cost of capital if interest rates fall or their credit worthiness improves, as they can call back these stocks from the shareholders and reissue them at a lower dividend rate.
  3. For the investor, this creates the risk of the stock being called away before they have realized their desired return on investment. However, to compensate for this added risk, callable preferred stocks usually offer a higher dividend yield.

Importance

Callable Preferred Stock is an important finance term because it allows corporations to have significant flexibility in managing their financial structure.

Issuing Callable Preferred Stock means that the issuing company reserves the right to buy back or “call” these stocks at its discretion, typically at a predetermined price.

This can be a strategic decision made when the company foresees that interest rates are going to fall, as it allows the company to repurchase its high-yielding preferred stock and reissue new stocks at a lower dividend rate, thereby saving on dividend payment costs.

Therefore, understanding the implications of Callable Preferred Stock is essential for both investors, who need to be aware of the risks associated with their potential recall, and corporations seeking efficient and flexible ways to manage their capital structure.

Explanation

Callable Preferred Stock serves as a type of investment security often issued by corporations to investors. It primarily aims to raise capital for the business while providing shielding mechanisms against adverse market conditions.

This type of stock carries the unique feature that the issuing company has the right, though not the obligation, to ‘call’ back or redeem the stock at a certain price and predefined time. This typically occurs when the corporate interest rates drop significantly, and companies find it easier to issue new lower-paying preferred stocks rather than continuing to pay the high dividends of the outstanding callable preferred stocks.

In terms of its application, companies use Callable Preferred Stock as a strategic financial tool. For example, it gives the issuer an edge in flexibility, as it can redeem the shares when the interest rates are low and re-issue shares at a lower dividend rate, thus reducing the cost of financing.

Moreover, these stocks can act as a support to the company’s creditworthiness, as they can call back stocks to avoid defaulting on dividend payments in monetary crunch scenarios. For investors, Callable Preferred Stocks provide an opportunity to earn fixed dividends, although there are inherent call risks.

Examples of Callable Preferred Stock

**Alphabet Inc. (Google):** In 2013, Google issued a particular type of callable preferred stock, called Class C shares. These shares hold no voting rights, but they can be bought back by the company at any time at their discretion. This gives Google the power to determine when and if it wants to repurchase these shares, offering flexibility in managing its financial portfolio.

**Bank of America Corp.:** In 2007, prior to the financial crisis, Bank of America issued a series of callable preferred stocks. When the company’s finances were distressed during the crisis, they utilized this feature to call back the preferred shares. This course of action allowed it to curb payment of the higher dividends accorded to these preferred stocks and subsequently save money.

**Walmart Inc.:** In the late 2000s, as part of a strategy to restructure its capital, Walmart issued callable preferred stocks. These shares offered investors a set dividend payout, but also contained a clause allowing the company to buy back the shares after a certain date. This was advantageous to Walmart because it enabled the company to potentially lower their cost of capital if interest rates dropped or the company’s credit rating improved by calling the stock and reissuing new preferred stock at a lower dividend rate.

FAQ: Callable Preferred Stock

What is Callable Preferred Stock?

A Callable Preferred Stock is a type of preferred stock in which the issuer has the right to call in, or redeem, the stock at its discretion. This means the corporation has the option to buy the stock back from the stockholders at a certain price after a certain date.

What are the benefits of Callable Preferred Stock to issuers?

Companies may choose to issue Callable Preferred Stocks because it gives them the flexibility to reduce their cost of capital if interest rates fall or if the company’s credit quality improves. They can redeem the existing preferred stock and reissue new preferred shares at a lower dividend rate.

What are the risks for investors?

The main risk for an investor in Callable Preferred Stock is “call risk” which is the risk that the issuing company will redeem the stock if it’s in their best interest, which is usually when interest rates are low. Therefore, the investors may have to reinvest their earnings at a lower interest rate.

How is the call price determined?

The call price of a Callable Preferred Stock is pre-determined at the time of issuance and is written in the stock’s prospectus. It often includes any declared but unpaid dividends.

How can I identify if a preferred stock is callable?

The terms of the preferred stock, including whether it’s callable or not, should be stated clearly in the stock prospectus at the time of issuance. Always make sure to read this document carefully before making an investment.

Related Entrepreneurship Terms

  • Call Price: This is the price at which the issuer can redeem or buy back the preferred shares from the preferred shareholders.
  • Dividends: This refers to the returns that preferred shareholders receive, typically on a fixed schedule.
  • Call Date: This is the specific date when the issuer of a callable preferred stock has the right to redeem the shares.
  • Call Protection: This is a period during which the issuer of the preferred stock cannot buy back the shares.
  • Call Premium: This refers to an amount over the par value that an issuer may have to pay for the redemption of callable preferred stock before its maturity date.

Sources for More Information

  • Investopedia: A comprehensive online financial education platform that offers an array of finance terms including Callable Preferred Stock.
  • The Balance: A personal finance platform that provides well-researched and practical advice, including topics such as Callable Preferred Stock.
  • Corporate Finance Institute: A provider of online finance courses and certification programs, offering educational content regarding various financial securities including Callable Preferred Stock.
  • The Motley Fool: A multimedia financial-services company that provides a range of financial solutions, and covers a wide range of financial topics, including Callable Preferred Stock.

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