Non callable preferred stock

What Is Non-Callable Preferred Stock?

Non-callable preferred stock is a type of preferred stock that the issuing company cannot redeem or "call back" before its maturity date, if it has one, or at any point if it is perpetual. Unlike common stock, preferred shares typically do not carry voting rights but offer a higher claim on a company's assets and earnings, particularly in the distribution of dividends and during liquidation. Within the broader category of Equity Securities, non-callable preferred stock blends characteristics of both debt and equity, often appealing to investors seeking a more stable, fixed income stream without the concern of the issuer repurchasing the shares.

History and Origin

The concept of preferred stock emerged in the mid-19th century in the United States, with the Pennsylvania Railroad Company often cited as the first to issue such shares.⁸ Initially, these shares were designed to offer investors a more secure form of investment than common equity, providing a fixed dividend payout and a priority claim on company assets in the event of financial distress.⁷

Over time, various features were introduced to preferred stock, including call provisions, which granted the issuing company the right to repurchase the shares. The distinction of non-callable preferred stock arose in contrast to these callable varieties, offering investors the assurance that their shares could not be involuntarily redeemed by the issuer. This non-callable feature has been a significant aspect for investors prioritizing long-term income stability and protection against reinvestment risk.

Key Takeaways

• Non-callable preferred stock cannot be repurchased by the issuing company, providing investors with certainty regarding their long-term ownership and income stream.
• Holders typically receive fixed dividend payments, which take precedence over common stock dividends.
• In a liquidation event, non-callable preferred stockholders have a higher claim on the company's assets than common shareholders but are subordinate to bondholders.
• These shares generally do not come with voting rights, limiting shareholder influence on corporate governance.
• The non-callable feature eliminates the "call risk" often associated with redeemable securities, where an issuer might repurchase shares when prevailing interest rates decline.

Formula and Calculation

While there isn't a specific formula unique to non-callable preferred stock itself, its valuation and the calculation of its yield are central to understanding its investment profile. The most common calculation for preferred stock is its dividend yield.

The dividend yield of a non-callable preferred stock, like any preferred stock, is calculated as:

For example, if a non-callable preferred stock pays an annual dividend of $2.50 per share and is currently trading at a market price of $50 per share, its dividend yield would be:

This calculation helps investors compare the income generation of different preferred stocks and other income-producing investments.

Interpreting the Non-Callable Preferred Stock

The non-callable feature of preferred stock is a significant advantage for investors seeking predictable, long-term income. Without the risk of the issuer calling the shares, investors can rely on a consistent stream of dividend payments over an extended period, or even perpetually, making it a suitable investment vehicle for income-focused portfolios. This stability is particularly valuable in declining interest rate environments, as the investor is not forced to reinvest capital at potentially lower yields.

However, this feature also means that non-callable preferred stock may not experience significant capital appreciation. Its market price tends to be more sensitive to changes in prevailing interest rates, much like a bond. If interest rates rise, the fixed dividend of an existing non-callable preferred stock becomes less attractive, potentially causing its market price to fall. Conversely, if rates fall, its fixed dividend becomes more appealing, which may support its price, but without the risk of a call.

Hypothetical Example

Consider XYZ Corp. issues a non-callable preferred stock with a par value of $100 and an annual dividend rate of 5%. This means investors will receive $5 in dividends per share annually.

An investor, Sarah, purchases 100 shares of this non-callable preferred stock for $10,000. She expects to receive $500 in dividends each year ($5 per share x 100 shares).

Several years later, prevailing market interest rates drop significantly. Many companies with callable preferred stock issued at higher rates choose to redeem those shares to reissue new preferred stock at lower dividend rates. However, because Sarah holds non-callable preferred stock from XYZ Corp., the company cannot repurchase her shares, regardless of the drop in interest rates. Sarah continues to receive her $500 annual dividend, providing a stable income stream that is now more attractive relative to newer preferred stock issues. This illustrates the benefit of the non-callable feature in protecting investors from reinvestment risk in a falling rate environment.

Practical Applications

Non-callable preferred stock serves various purposes for both issuers and investors within the capital structure of a company. Companies often issue non-callable preferred stock as a means of raising capital without diluting the voting power of common stock shareholders. It also allows companies to secure funding without increasing their debt levels, which helps maintain a healthier debt-to-equity ratio on their balance sheet.

For investors, non-callable preferred stock is particularly appealing to those seeking stable and predictable income. Institutional investors, such as insurance companies and pension funds, frequently invest in preferred stock for its reliable dividend payments and higher yield compared to many bonds.⁶ The non-callable nature ensures this income stream is not interrupted by an issuer's decision to repurchase the shares. This type of security can be a valuable component for income-oriented portfolios, providing a steady stream of cash flow.

Limitations and Criticisms

Despite their advantages, non-callable preferred stocks have certain limitations. One primary criticism is their limited potential for capital appreciation. Unlike common stock, which can see substantial price growth based on company performance, non-callable preferred stock prices tend to fluctuate mainly with interest rates.⁵ If an investor's primary goal is significant capital gains, non-callable preferred stock may not be the most suitable investment vehicle.

Furthermore, while non-callable preferred stock offers dividend priority over common stock, it is still subordinate to debt in a liquidation scenario.⁴ This means that in the event of a company's bankruptcy, bondholders are paid before preferred stockholders. The fixed dividend payments are also not guaranteed; if a company faces financial difficulties, it can suspend preferred dividends without triggering default, unlike interest payments on bonds.³ This introduces a degree of risk management that investors must consider. Academic research highlights that preferred stock, being a hybrid security, presents a complex interplay of debt and equity features, influencing a firm's risk profile and cost of capital.²

Non-Callable Preferred Stock vs. Callable Preferred Stock

The fundamental difference between non-callable preferred stock and callable preferred stock lies in the issuer's right to redeem the shares.

This distinction is crucial for investors. Holders of non-callable preferred stock benefit from long-term income predictability without the concern of the issuer redeeming their shares, particularly when prevailing interest rates fall. Conversely, callable preferred stock offers the issuer flexibility to manage its capital structure more dynamically, potentially refinancing at lower dividend rates, but it introduces reinvestment risk for the investor. The U.S. Securities and Exchange Commission (SEC) provides guidance on the redemption of preferred shares, outlining conditions and implications for issuers.¹

FAQs

Do non-callable preferred stocks have voting rights?

Generally, no. Non-callable preferred stock, like most types of preferred stock, typically does not grant shareholders any voting rights in corporate matters. This differentiates them from common stock, which usually comes with voting privileges.

Are non-callable preferred stocks truly perpetual?

Many non-callable preferred stocks are indeed perpetual, meaning they have no maturity date and remain outstanding indefinitely. However, some non-callable preferred stocks may have a stated maturity date, after which the par value is returned to the investor. It's essential to review the specific terms of each issuance.

How does a non-callable feature benefit an investor?

The non-callable feature provides significant benefit to investors by eliminating the risk that the issuing company will repurchase their shares. This means investors can rely on a consistent and predictable stream of dividends for the life of the security, regardless of changes in interest rates. This removes reinvestment risk management that is present with callable securities.