Retractable Preferred Shares

What Are Retractable Preferred Shares?

Retractable preferred shares are a specific type of preferred stock that lets the owner sell the share back to the issuer at a set price. Typically, the issuer can force the redemption of the retractable preferred share for cash when the shares mature. Sometimes, instead of cash, retractable preferred shares can be exchanged for common shares of the issuer. This may be referred to as a soft retraction compared with a hard retraction where cash is paid out to the shareholders.

Understanding Retractable Preferred Shares

Preferred shares resemble a fixed-income bond that pays dividends instead of interest. The retractable feature allows for the value of these shares to remain relatively steady around the retraction price, or par value, as compared to the price of traditional preferred shares that fluctuate with changes in interest rates.

Since the preferred shares can be retracted at a set rate, unless the company is facing financial troubles and may not be able to pay preferred shareholders for their shares, the price will typically find a floor near the retraction price set in the prospectus. The terms on each retractable preferred share, and from each company, may differ though.

Typically, retractable preferred shares are issued with a maturity date and when the maturity date comes preferred shareholders can exercise their right to redeem their shares for the cash (face value), or possibly for common shares of the issuer if that option is available.

Ways Retractable Preferred Shares are Used

The terms that bind retractable preferred shares must be explained in a prospectus from the issuer. If the issuer sets a maturity date on preferred shares, these are retractable since they can compel shareholders to redeem those shares for the face value laid out in the prospectus.

Retractable preferred shares might be issued by companies that foresee that they will have cash in the future to pay back the preferred shareholders, but at the time of issuance, they didn't have cash and therefore issue preferred shares to raise cash. They issue retractable preferred shares so that they don't have to pay preferential dividends indefinitely. The shares only exist for a set time period.

The expectation is that by offering retractable preferred shares, they will be able to raise and access capital more immediately for operations that could otherwise be delayed or limited. Once the company has generated the anticipated additional capital, it could be in a better position to buy back those shares. When those shares later mature, shareholders will sell back the preferred shares and the company will not need to continue making dividend payments.

There may be terms, however, that require the company to pay all the dividends within a given period before the company can retract the shares, thus ensuring the investors receive the cumulative dividends they are due.

Redeemable Versus Retractable Preferred Shares

Retractable preferred shares are comparable to (but still different from) redeemable preferred shares. Redeemable means that the company can call in their preferred shares at any time after a certain set date at a price outlined in the prospectus. This is beneficial for the company if they have issued 5% preferred shares but could now offer preferred shares at 3% because interest rates or preferred share yields have dropped. They can call in their more expensive preferred shares and issue lower dividend rate ones.

Example of Retractable Preferred Stock

Assume that a company needs cash now, but doesn't want to dilute their current common shareholders by issuing more common stock. One option is to issue preferred shares. The company expects to have more cash in the future, and therefore doesn't need to pay preferred share dividends indefinitely.

They opt to issue retractable preferred shares with a 4% dividend payment. The shares have a face value of $100 and therefore a total yearly dividend payment of $4. The shares will mature in five years, at which point the company can force the preferred shareholders to redeem their shares for $100 in cash.

Since the shareholders will be paid out $100 at the end of five years, the share price should be relatively stable compared to preferred shares without a maturity date. That's because if the shares don't have a maturity date their value will fluctuate based on interest rate and yield changes in the marketplace. While retractable preferred shares may fluctuate, they tend to fluctuate less than non-retractable preferred shares.

The investors will want to check if the preferred shares are cumulative or noncumulative. If they are cumulative, any missed dividends are still owed to shareholders. If the shares are non-cumulative or if the company misses a payment then the shareholder just has to take it on the chin.