Watch Out for 'Call-Eligible' Preferreds

by: Tim McPartland

We follow just over 700 Trust and Regular preferred stock issues in our database - which we believe represents a large percentage of all publicly traded preferred shares.

A quick review shows that over 80% of the issues are 'call eligible.' By call eligible we mean that conditions required to be fulfilled to make the issues callable have been attained. The primary condition that has been fulfilled is time - that time being five years since original issue.

In recent years virtually all Trust and Regular preferred issues have been callable five years after issue. These are generally $25 issues (although there are some $10 and $50 issues also), and they are callable at par plus accrued dividends.

Of course there are many $100 issues outstanding, and these have typically been callable from the day they were first issued. Seldom are these called, as they were issued many years ago at rates that were very favorable to the issuer. It is rare that these are called as the cost of capital is so favorable to the issuer.

The point is that you must be aware of the call dates on preferred shares (as well as debt issues). Simply chasing a given dividend yield can result in major hits to your portfolio.

Below is a chart of a preferred issue that had just such an event happen to it.

This is a chart of the GDL Fund (formerly the Gabelli Global Deal Fund) preferred 'A' shares. This is an 8.5% $50 issue that is callable any time.

You can see that investors in their zeal to capture high yield drove the price $4.50 over the call price - then over 2-3 months the price worked its way somewhat lower until GDL announced a rights offering on February 23rd of 7% preferreds, which essentially offered the holders of the 8.5% issue a one-for-one swap. While not an outright call, the effect is the same (as they later anounced they plan to call the balance of the 8.5% issue in the near future). You can see that buyers from 6-8 months ago have at a minimum dea' money (since they would have received some dividends) - or if they sold, had a loss of maybe 5% on their investment.

The lesson is quite simple: Know if you have a callable issue, and in most cases do not pay above par value (plus accrued dividends). You can bet that if it is beneficial to call the issue, it will be called. If the issuer receives no benefit from the call (such as a substantially lower interest rate) it will not be called.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.