Callable Preferred Stock

Written by True Tamplin, BSc, CEPF®

Reviewed by Subject Matter Experts

Updated on July 12, 2023

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What Are Callable Preferred Stocks?

A callable preferred stock is a type of preferred stock that grants the issuing company the right, but not the obligation, to repurchase the stock at a specified price after a predetermined date.

This feature allows the issuer to retire the preferred shares if interest rates decline or if the company's financial position improves.

Callable preferred stocks have several distinguishing features, including a fixed dividend rate, a call provision, and a potential conversion feature that allows investors to exchange their preferred shares for common stock.

Companies issue callable preferred stocks for various reasons, such as raising capital with flexibility, lowering financing costs, and managing their equity structure more efficiently.

Key Features of Callable Preferred Stocks

Dividends

Fixed Dividend Rate

Callable preferred stocks typically pay a fixed dividend rate, providing investors with a stable and predictable income stream.

Cumulative vs Non-cumulative Dividends

Dividends on callable preferred stocks can be cumulative or non-cumulative. Cumulative dividends accrue if the company misses a dividend payment, while non-cumulative dividends do not accrue if a payment is missed.

Call Provision

Call Price

The call price is the amount the issuer must pay to repurchase the callable preferred stock. The call price is often set at a premium above the stock's par value to compensate investors for the call risk.

Call Date

The call date is the earliest date the issuer can exercise its right to repurchase the callable preferred stock.

Call Protection Period

The call protection period is the time between the issuance of the callable preferred stock and the first call date. During this period, the issuer cannot exercise its call option, providing investors with a degree of protection.

Conversion Feature

Convertible vs Non-convertible Callable Preferred Stocks

Some callable preferred stocks have a conversion feature that allows investors to convert their preferred shares into common stock at a predetermined ratio. This feature provides investors with the potential for capital appreciation if the common stock's value increases.

Conversion Ratio and Price

The conversion ratio determines the number of common shares an investor will receive for each preferred share they convert. The conversion price is the common stock's price at which the conversion takes place.

Credit Ratings

Callable preferred stocks often have credit ratings assigned by rating agencies, indicating the issuer's creditworthiness and the stock's risk level.

Advantages of Callable Preferred Stocks

For Investors

Higher Dividend Payments

Callable preferred stocks typically pay higher dividends compared to common stocks, providing investors with a consistent income stream.

Priority over Common Stockholders

In the event of liquidation or bankruptcy, preferred stockholders have priority over common stockholders when it comes to dividend payments and asset distribution.

For Issuers

Capital Raising Flexibility

Callable preferred stocks provide companies with flexibility in raising capital, as they can retire the stock when it is advantageous to do so.

Lowering Financing Costs

If interest rates decline or the company's credit rating improves, the issuer can call the preferred stock, potentially lowering its financing costs by issuing new preferred shares at a lower dividend rate.

Control Over Equity Structure

Callable preferred stocks give the issuer control over its equity structure by allowing it to retire preferred shares and replace them with common stock or other securities.

Advantages of Callable Preferred Stocks

Risks Associated With Callable Preferred Stocks

Call Risk

Investors face call risk when the issuer exercises its right to repurchase the callable preferred stock, potentially causing the investor to lose future dividend income and seek alternative investments.

Interest Rate Risk

Callable preferred stocks are sensitive to changes in interest rates. If rates rise, the market value

of the preferred stock may decline, as investors seek higher-yielding investments. Conversely, if interest rates fall, the issuer may call the preferred stock, forcing investors to reinvest at lower rates.

Credit Risk

Investors in callable preferred stocks are exposed to credit risk, as the issuer's financial health may deteriorate, leading to missed dividend payments or, in extreme cases, bankruptcy.

Market Risk

Callable preferred stocks are subject to market risk, as their prices can fluctuate due to factors such as investor sentiment, economic conditions, and industry-specific events.

Limited Growth Potential

Compared to common stocks, callable preferred stocks generally have limited growth potential, as their dividends are fixed and their value is less likely to appreciate significantly.

Risks Associated With Callable Preferred Stocks

Investing in Callable Preferred Stocks

Considerations for Investors

Dividend Yield and Rate

Investors should evaluate the dividend yield and rate of callable preferred stocks to assess their potential income generation.

Call Features and Protection Period

It's essential to understand the call features and protection period of a callable preferred stock, as these factors influence the investment's potential income and risks.

Credit Ratings

Investors should consider the credit ratings of callable preferred stocks to gauge the issuer's creditworthiness and the investment's overall risk.

Conversion Features

If a callable preferred stock has a conversion feature, investors should evaluate the conversion ratio and price to determine the potential for capital appreciation.

Investment Strategies

Income Generation

Callable preferred stocks can serve as a source of income for investors seeking stable dividend payments and lower risk compared to common stocks.

Portfolio Diversification

Investing in callable preferred stocks can provide diversification benefits by adding a different asset class to an investor's portfolio, potentially reducing overall risk.

Hedging Interest Rate Risk

Callable preferred stocks with a conversion feature can help investors hedge against interest rate risk, as the option to convert to common stock may provide potential capital appreciation if interest rates rise.

Callable Preferred Stocks in the Financial Market

Market for Callable Preferred Stocks

The market for callable preferred stocks consists of various issuers, including corporations, financial institutions, and utilities. These stocks are traded on stock exchanges and can be bought and sold through brokerage accounts.

Callable Preferred Stock Indexes and Funds

Several indexes and funds track the performance of callable preferred stocks, providing investors with benchmarks and investment options. Examples include the S&P U.S. Preferred Stock Index and the iShares U.S. Preferred Stock ETF (PFF).

Callable Preferred Stock Issuance Trends

Callable preferred stock issuance trends can be influenced by factors such as interest rates, economic conditions, and corporate financing needs.

In periods of low interest rates, companies may be more likely to issue callable preferred stocks to lock in lower financing costs while retaining the option to call the stock if rates decline further.

Conclusion

Callable preferred stocks are a unique type of preferred stock that provides investors with higher dividend payments and priority over common stockholders. They offer issuers flexibility in raising capital and managing their equity structure.

However, investors must consider the risks associated with callable preferred stocks, such as call risk, interest rate risk, and limited growth potential.

Callable preferred stocks play a crucial role in the financial market by providing companies with an alternative means of raising capital and giving investors an additional asset class to diversify their portfolios and generate income.

The future outlook for callable preferred stocks will likely be influenced by factors such as interest rates, economic conditions, and investor appetite for income-generating investments.

As the financial market continues to evolve, callable preferred stocks will remain a relevant and valuable investment option for both issuers and investors.

Callable Preferred Stock FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.

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