Preferred shares are a special ‘hybrid type’ equity security issued by corporations to raise capital. Preferred shares are structured to provide both the issuing corporation, and the holders with several unique characteristics. Preferred shares are a hybrid class of security having properties of both equity and debt. From an overall perspective, they can provide security of capital and right to receive income. Preferred shares rank above common shares for security of capital and right to receive income and below bonds.
Preferred shares take their name from the fact that they feature senior asset claims above shares of common stock. This seniority means that preferred shareholders are to be paid prior to common shareholders with regards to dividends, and from any asset liquidation sales that occur due to corporate bankruptcy. In terms of dividend payments, preferred shareholders must also receive dividends before any dividends are paid out on a corporation's common stock. Preferred share asset claims, however, are junior to bonds. The corporation is legally mandated to pay interest on bonds, but pays out preferred dividends at its discretion. The precise details as to the structure of preferred stock is specific to each issue. Preferred shares, like other legal arrangements, may specify nearly any right conceivable. The most common type of features for preferred shares are:
Cumulative - Non Cumulative
Preferred stock can either be cumulative or noncumulative. A cumulative preferred requires that if a company fails to pay any dividend or any amount below the stated rate, it must make up for it at a later time. Dividends accumulate with each passed dividend period, which is generally quarterly. When a dividend is not paid in time, it has been missed and all missed dividends on a cumulative preferred stock become dividend in arrears but still due before dividends can be paid on common shares. A preferred share that doesn't have this feature is known as a noncumulative. Dividends missed are lost forever if not declared.
Preferred shares have a par value amount at which the issuer can call. The call is at the option of the issuer, and is generally always $25, known as the par value. The date on which the preferred shares can be called is set at the time of the IPO and is generally 5 years.
Dividends - Amount
Almost all preferred shares have a specified dividend amount. The dividends are specified as a percentage of the par value and can either be a fixed amount or variable. If the amount is variable the yield will be reset to a fixed spread from a benchmark yield as of a specific date. Fixed dividend amounts are paid until the issue is called, however the right to call remains with the issuer. Variable dividends are typically based on the yield of the 5 year Government of Canada bond as of the reset date. Reset dates are generally 5 years from the date when the preferred share series was issued.
Dividend & Voting Rights
Some preferred shares have special voting rights that are more limited than the voting rights of common shareholders. Preferred shares generally gain voting rights when the preferred dividends are in arrears.
There are certainly pros and cons when looking at preferred shares. Preferred shareholders have priority over common stockholders on earnings and assets in the event of liquidation and they have a fixed dividend (paid before common stockholders), but investors must weigh these positives against the negatives, including giving up their voting rights and less potential for appreciation
You can create a diversified portfolio of money market securities, preferred shares, and common stocks to manage risks and invest for growth. The money market securities and preferred shares will provide for liquidity and investment income, respectively, in most economic scenarios.
Preferred shares in Canada generally come in two main categories, perpetual fixed rate preferred shares and rate-reset preferred shares. Fixed rate perpetual preferreds pay a fixed dividend rate until they are called by the issuer. The rate reset versions pay a fixed rate of dividends for the fixed rate period, typically 5 years then the rate is adjusted to a benchmark rate. The benchmark rate is typically the 5 year Government of Canada bond. A single company may issue several classes of preferred stock each with different rights.
Additional possible advantages of preferred shares include reduced rates of taxes, stability of capital and security of income.
IncomeResearch.ca provides complete listings of Canadian and select international preferred shares. We are available to assist clients with developing preferred share portfolio strategies.
Produced by H.C. Levant, – Reproduction of this material in part or it’s entirety is subject to copyright licensing agreements and is forbidden except only with the express written consent of the author.