 Personal Finance PowerPoint Presentation. Callable Preferred Stock. Prepare to get financially fit by practicing personal finance. Most of this information comes from Investopedia. Callable Preferred Stock, which you can find online. Take a look at the references. Resources continue your research from there. This is by Adam Hayes, updated March 28th, 2022. In prior presentations, we've been taking a look at investment goals, investment strategies, investment tools, keeping in mind the two major categories of investments that being fixed income, typically bonds, equities, typically on the common stocks. We're looking at the callable preferred stock. Let's first just think about the preferred stock component that we've talked about in prior presentations, which technically falls on the equity side of things, but functions similar to or functions kind of like a bond. So functionally, it kind of falls in between the fixed income and the equity side of things. So a quick recap, what are bonds? We can think of them kind of like us giving or loaning money to the issuer of the bond, typically a government or a corporation and return for the fixed income of interest payments, typically. And then we're gonna be receiving the amount of the face amount at the maturity of the bond. If they don't pay us the interest payments, they will be defaulting on the bond and that will cause them problems. So it's pretty solid fixed income. When we look at the common stock side of things, we're looking at ownership in the company, remembering that companies are separate legal entities, breaking out ownership into equal unit shares called stocks. The stocks then are often traded when we're looking at them by publicly traded companies on an exchange. And those are usually what we're thinking about when we're thinking about the common stocks. The preferred stock, let's not take into the callable component here, just talking preferred stock are items on the equity side of things. They're preferred because they usually have to get paid the dividends to the preferred stock before any dividends are paid to the common stock. And if there was liquidation to the company, they'd have to pay the preferred stockholders first. Preferred stock is not better than common stock, however, because if there was an upside, the economy did quite well, the business did quite well, the common stockholder value would typically increase more than the preferred stock. The preferred stock dividends are usually gonna be more guaranteed. That's why they're similar to a fixed income, similar to a bond type of situation. Okay, keeping that in mind, what is callable preferred stock? Callable preferred stock is a type of preferred stock that the issuer has the right to call in or redeem at a price set price after a defined date. So in other words, they can call them back. So the company can call them back and that of course is gonna be a benefit to the company side of things, not so much for the investor side of things. So that's, you can see how the effect on the price would be if you're looking at preferred stock that has the callable feature, which compared to stocks that do not have the callable feature. So callable preferred stock terms such as the call price, the date after which it can be called and the call premium, if any, are all defined in prospectus and cannot be changed later. So they're part of the terms basically of the preferred stock in the prospectus when the stocks are issued. Understanding callable preferred stock. Callable preferred stock, also known as redeemable preferred stock is a popular means of financing for large companies combining the elements of equity and debt financing. So redeemable preferred shares, trade on many public stock exchanges, these preferred shares are redeemed at the discretion of the issuing company, giving it the option to buy back the stock at any time after a certain set date at a price outlined in the prospectus. So that means it's a benefit to the company because the company, by issuing the preferred stock they're basically financing the company. They're trying to get money. They're trying to get money so they can invest in things like equipment, buildings and so on and grow, use that to generate revenue. And like when we refinance a home or like when we finance a home, for example, taking out a loan on the home, it would be nice if at a future point in time we could refinance if the market conditions were good. And the same kind of concept is here. If they can call back the preferred stock which is similar in structure to a bond, then if market conditions become more favorable they would like to be able to do that and possibly structure their financing in a less costly way. So this is beneficial for the company if they have issued 5% preferred shares but could now offer preferred shares at 3% because interest rates or preferred shared yields have dropped. So in other words, similar to us on a mortgage if we had a mortgage and we had the fixed rate mortgage and then the interest rates drop, well, it's like, well, now I'd like to be paying the lower interest rates. Is there any way I could do that? Well, I'd have to restructure my whole loan in order to do that same thing here. The company would like to be able to say, hey, you know, things are better at this point in time. I can issue preferred stocks and be paying lower amounts of payments. So we would like to restructure if we could that would be given them the opportunity. On the investment side of things we would like to be able to say, no, keep paying us the 5%, right? Because now we're on the other side of the table as with our mortgage scenario. So we would like to lock them in to be paying the 5% not let them restructure or pay out so they can restructure at the 3%. So they can call and their more expensive preferred shares and issue lower dividends at rate ones. So callable preferred stock is routinely redeemed by corporations. This is done by sending a note to shareholders detailing the date and conditions of the redemption. For example, on January 13th, 2021, City Group Incorporated announced that it was redeeming its series S preferred stock effective February 12th. This means shareholders of the shares needed to return their shares on that day in exchange for payment of their capital outstanding dividends and a premium as the case may be. Benefits of callable preferred stock issue were advantages. So this is the company side of things. A callable preferred stock issue offers the flexibility to lower the issuers cost of capital if interest rates decline or if it can issue preferred stock later at a lower dividend rate. They have the capacity to refinance in essence. For example, a company that has issued callable preferred stock with a 7% dividend rate will likely redeem the issue if it can then offer new preferred shares carrying a 4% dividend rate. The proceeds from the new issue can be used to redeem the 7% shares resulting in savings for the company. Conversely, if interest rates rise after it issues the 7% preferred callable shares the company will not redeem them and instead to continue pay the 7% just like on our mortgage side of things. Obviously if the interest rates go up then I'm not gonna refinance to get to the higher to pay more interest, right? So if you're on the person who's lending side of things then it's nice to have the option to refinance if you could but if the market conditions do not reflect that then you keep going with where you're at and your interest rates that you're paying right now are lower than the market rates if the market's rates went up and you had your fixed rate. So the company is protected from rising financing costs and market fluctuations. So what are the investor advantages? What's my advantage? That's what I wanna know talking about the company. An investor owning a callable preferred stock has the benefit of a steady return. However, if the preferred issue is culled by the issuer the investor will most likely be faced with the prospect with the prospect of reinvesting the proceeds at a lower dividend or interest rate. So we can obviously we can get the return of investing in them but if they are culled they're going to be culled at a point in time when it's a favorable point in time to be refinancing for the issuer which means that the money that we're going to get we get the money at that point in time but we're probably not gonna be able to reinvest the money and get the same return we were getting before because the reason the company culled them is because the interest rates had changed meaning we're not gonna get as favorable a rate most likely with similar kind of investments. So issuers usually pay a cull premium at the redemption of the preferred issue which compensates the investor for part of this reinvestment risk. So when they cull them they have to pay back and they might pay back somewhat of a premium again to kind of compensate for that. So obviously just like with refinancing a home it's costly so they have to basically clear the cost of doing the process of refinancing and so on. Investors assure themselves of a guaranteed rate of return if markets drop but they give up some of the upswing potential of common shares in exchange for greater security. Cullable versus retractable preferred stock while cullable shares may be redeemed by the issuer retractable preferred shares or a type of preferred stock that lets the owner sell the share back to the issuer at a set price sometimes instead of cash retractable preferred shares can be exchanged for common shares of the issuer. This may be referred to as a quote soft and quote retraction compared with a quote hard and quote retraction where cash is paid out to the shareholders.