Callable Preferred Stock

Callable preferred stock is preferred stock that gives the issuing corporation the right, but not the obligation, to redeem the shares from holders at a specified call price after a certain date, buying back the stock rather than letting it remain outstanding indefinitely. The call feature belongs entirely to the issuer; preferred shareholders cannot force a redemption themselves under a callable structure, they can only be redeemed if and when the company chooses to exercise its right.

Preferred stock, unlike debt, typically has no stated maturity date, which means a company could otherwise be obligated to pay a fixed dividend rate indefinitely. Adding a call feature gives the issuer flexibility to retire the preferred stock later if market conditions change, most commonly if the company's cost of capital falls enough that refinancing with cheaper preferred stock, debt, or common equity becomes attractive relative to continuing to pay the original preferred dividend rate.

Because callability works against the investor's interest, callable preferred stock typically has to offer a somewhat higher dividend rate, or a lower issue price, than otherwise comparable non-callable preferred stock would require, compensating investors for accepting the risk that their shares could be redeemed away just as market conditions turn favorable for them to keep holding it. Investors analyzing callable preferred stock generally focus as much on the yield-to-call, assuming an early redemption at the first available call date, as on the stated dividend rate alone.

The call price for preferred stock is commonly set at par value plus a call premium, often declining on a set schedule the longer the stock remains outstanding, eventually reaching exactly par value after enough time has passed. The specific call price, the earliest call date, and the declining premium schedule, if any, are all fixed in the terms of the preferred stock at issuance and cannot be changed afterward without the company negotiating directly with holders.

Analysts reviewing a company's capital structure pay attention to whether preferred stock is callable and when the earliest call date falls, since an approaching call date can signal that the issuer may soon refinance the preferred shares, changing the company's future dividend obligations and capital structure in a way that a non-callable preferred issue, locked in on its original terms indefinitely, simply would not.

A company issues $25 par value callable preferred stock paying a 6% dividend, callable at $26 per share after five years. If market interest rates fall enough that the company could issue new preferred stock at only 4%, it has a clear incentive to call the existing 6% shares at $26 each, refinancing with cheaper preferred stock and immediately reducing its ongoing dividend obligation.

Because being called back is entirely the issuer's choice and tends to happen specifically when it is financially disadvantageous for the investor — interest rates have fallen and a better reinvestment option no longer exists — callable preferred stock generally has to offer a higher dividend rate than otherwise-identical noncallable preferred stock to attract buyers in the first place. Investors effectively accept a form of reinvestment risk unique to callable securities: they may be forced to give up an attractive income stream right when market conditions make it hardest to replace, which is exactly the risk the slightly higher stated dividend is meant to compensate for.