Callable Preferred Stocks: Definition, Feature, How Does It Work?

Definition:

Callable Preferred Stock is defined as a type of preferred stock that can be redeemed by the issuer at a given value before the maturity date.

Issuers mostly use this type of preferred stock for financing purposes, because it offers them substantial flexibility for redemption.

Therefore, it gives the option to the issuer to repurchase the shares back from the public at a predetermined price.

Callable preferred shares are of the same characteristics as compared to other preferred shares. The only difference between callable preferred shares, and normal preferred shares is the fact that callable preferred shares can be redeemed by the issuer, whereas other types of preferred shares have no set maturity date.

In the same manner, callable preferred shares are also entitled to dividend payments across the year. Callable preferred shares are termed as one of the most viable financing strategies for the company, because in the longer run, it does not hamper the ownership structure of the company.

This is because even if they are called back, the ownership structure is restored within the company.  

Features:

Callable Preferred Stocks are highly popular because of the much-needed flexibility it provides to the issuing company. Callable Preferred Stocks have the following salient features:

  • Callable Preferred Shares have no voting rights. Just like normal preferred shares, they are entitled to yearly (or quarterly) dividend payments. Therefore, they have no say in managing how the company runs and functions.
  • Callable Preferred Shares are redeemable. This means that they can be called back, or repurchased by the issuer. This rate is predetermined when those shares are issued.
  • Callable Preferred Shares can only be sold back to the company, when the company wants to repurchase those shares back. This cannot be done unless the company does not personally want to calls back shares.
  • Issuing callable preferred stocks comes with a price for the issuer in the form of call premium. This is because investors need to be compensated for the call back risk.
  • Regardless of the fact that the owner of the stock is meant to bear the loss associated with call back, if any, the strike price is decided to ensure that they are compensated for this loss.
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How do Callable Preferred Stocks work?

Callable Preferred Stocks are widely used by organizations in order to issue stocks or equity. In this regard, the following illustration is given to provide a deeper insight regarding the functionality of callable preferred stocks.

Riz Co. issued a callable preferred stock in 2010, with a payout yield of 10%. Despite the fact that this stock matures in 2030, yet Riz Co. has enlisted a call back option. As per this option, the shares are supposed to be callable in 2015 on 105% of the par value.

In the example above, it can be seen that Riz Co. has issued callable preferred stock. This means that they can repurchase the shares in 2015, at a higher price than what they were initially issued for.

The 105% of the par value implies that 5% is considered to be the Call Premium on the stocks when they are called back. From an investor’s perspective, they are going to be paid 1.05 times the par value of the shares that they had purchased back in 2010.

Advantages of Callable Preferred Stocks

Callable Preferred Stocks have the following advantages from the perspective of the issuing company:

  • Callable Preferred Stocks do not hamper the ownership structure of the company in the long term. When the shares are called back, the ownership structure (shareholding mix) is going to restore back to normal.
  • Callable Preferred Stocks are viable financing tools. This is because of the fact that they do not incur hefty financing charges. They are cheaper to issue if the company has authorized share capital. In the same manner, they do not necessarily require principal to be repaid to the investor, since calling back the shares is up to the discretion of the company, before the maturity.
  • Companies can arrange for paying back the amount of callable premium stocks in the longer run. This is greatly beneficial since it helps companies to plan the repayment plan which incorporates for the call premium.
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Limitations of Callable Preferred Stocks

Callable Preferred Stocks have the following limitations:

  • Regardless of the fact that callable preferred shares are highly flexible financing options for the company, yet it can be seen that they are also risky, because they guarantee a return (in the form of call premium), even when the market is not performing well. Therefore, this might lead to financial losses in this regard.
  • In the same manner, it is often difficult to sell the callable preferred stock. From the investors’ perspective, it might be a risky investment, so they might demand higher returns in exchange for investment callable preferred stocks.
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