Huge demand for high quality [1] preferred stocks has pushed up market prices. The sudden increase in demand has been caused by a large number of calls, all occurring within a very short period of time. So far this year we have seen seventeen high quality preferred stocks called by their issuing companies. That has to be a record pace [2].
These calls have pushed a large number of suddenly cash-rich preferred stock investors into the marketplace as buyers, all looking to replace their called shares at the same time, hence pushing up prices. With this increase in market prices, many preferred stock investors are currently sitting on significant, but unrealized, capital gains in their preferred stock portfolio, leading many to wonder if they should pocket those gains by selling now.
If the issuing company decides to call (redeem) your shares, the opportunity to cash in those gains evaporates instantly, as the market price will fall toward par (usually $25 per share) as soon as a call is announced. Several of the issues called this year were selling for prices well above their par values just before the call announcement, so many of those holding shares at the time would have dearly loved to have known that a call was heading their way.
This is especially true of high quality preferred stock shares that are so widely held. Most of the 40 callable high quality preferred stocks that are currently trading on U.S. stock exchanges closed on Friday, April 20 for a market price above their respective par values.
What Is The Likelihood Of A Call?
In most cases, a company will call a preferred stock if it saves them money to do so. For example, earlier this year Public Storage (PSA), taking advantage of today's low rates, issued PSA-T, a new preferred stock with a 5.750% dividend rate. The proceeds generated by the new PSA-T were used to call PSA-M, issued in 2007, that was costing Public Storage 6.625% in annual dividend expense. Introducing a lower payer to call an older, higher payer produced an instant 0.875% savings to the company (6.625% minus 5.750%).
But what about a case where the savings was only, say, 0.500% or even as low as 0.250%? What amount of savings to the issuing company is compelling enough to trigger a call? Once we identify the amount of dividend expense savings that tends to trigger a call, you can use that knowledge to assess whether or not selling and collecting your capital gains now is a move that you should be considering.
To understand the likelihood of a call we have to take a look at how companies have made this decision in the past. How much dividend savings has it taken to trigger a call and how does that trigger point relate to today's preferred stock market?
The Trigger Point
High quality preferred stocks become callable five years after they are introduced to the marketplace. So, in order to determine the likelihood of a call, we need a study period where rates were lower five years after the date of issuance. The Global Credit Crisis of late-2007 through 2009 pushed dividend rates up much higher than they are today (all the way to 9.6%). With these crisis-era issues becoming callable between 2012 and 2014, the crisis period will provide a great study period (lots of calls as we are already starting to see), but we'll have to wait a couple more years for more of that data to materialize.
Preferred stocks issued during 2003 through 2006 do not work well for this analysis since dividend rates were lower during that period than they were five years hence (2008 through 2011) during the crisis.
But high quality preferred stocks issued during 2001 and 2002 are just what we are looking for. These preferred stocks became callable during 2006 and 2007, respectively. Dividend rates were lower during 2006 and most of 2007 than they were five years earlier, creating favorable conditions for calls. So by looking at preferred stocks issued during 2001 and 2002, we are able to assess how much savings to the issuing company was required to trigger a call.
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