What is Callable Preferred Stock?

Callable preferred stock is preferred shares in a business that can be bought back by the issuer at a certain price. The call price and other conditions are included in the indenture associated with the stock.

Example of Callable Preferred Stock

Henry Corporation issues 6% callable preferred stock. The par value of each share is $100, and the company pays $6 per share annually, paid quarterly. This stock contains a call feature, under which Henry can call the stock at a price of $105 per share, starting five years in the future.

This means that shareholders will receive a fixed dividend of $6 per share annually, paid quarterly. Starting in five years, the company has the option to call (redeem) the stock at $105 per share. This price includes a $5 premium above the par value as compensation for the early redemption. If market interest rates drop below 6%, the company might decide to call the stock and reissue new preferred shares with a lower dividend rate to save on costs.

Advantages of Callable Preferred Stock

A key advantage of callable preferred stock is that its call feature allows the issuer to recall shares if the market interest rate declines, and replace it with lower-cost preferred stock or bonds. The result is an overall lower cost of capital for the issuer. The call feature also allows the issuer to buy back preferred stock simply because it wants to overhaul its capital structure - such as by shifting to a more debt-heavy financing structure, or by shifting to more common stock.

Disadvantages of Callable Preferred Stock

Callable preferred stock is a disadvantage for the investor, which may be forced to return a high-payout investment. Consequently, the existence of a call feature tends to put a cap on the market price of these shares.