What are the basic features of a preferred share?
The basic features of a preferred share include the following:
- A Redemption/Callable (Redeemable/Callable Preferred) feature will grant the issuing corporation the right to purchase the investor’s preferred shares on or after certain dates in the future. The issuer must advise the shareholder of their intention to purchase the shares and the price paid will be according to a set schedule established at the time the shares were issued. For most preferred shares the redemption price will initially be higher that the share’s par value and decline toward the par value over time. Upon receipt of a notice of redemption,the shareholder will be entitled to the redemption price plus accrued and unpaid dividends to the date of redemption.
The redemption price(s) and the specific redemption dates are outlined in the preferred share’s initial documentation, and can be found at the issuing corporation’s website and/or through the purchase of publications such as Financial Post’s Annual Preferreds and Derivatives, Owen Media Partners.
Typically, redemption features are in force from a certain date onward at a price that declines, toward the share’s stated par value, with time. The higher initial redemption price, above par value, offers the investor some compensation in the event the issuing corporation decides to redeem the shares within a short time period after issuance.
Often the redemption will be made with a cash payment from the issuing corporation. In some instances the redemption can be completed by issuing shares of another class, such as another preferred share or common shares.
Note: When faced with a redemption notice shareholders should consult with their income tax advisor to ensure the best course of action to minimize the income tax impact.
- A Retraction (Retractable preferred) feature will give the shareholder the right to force the issuing corporation to repurchase the preferred share for a specified price, on a specific date. Typically, the retraction price is equal to the shares par valueand the shareholder is entitled to receive all accrued dividends up to the retraction date.Retractable preferred shares may have multiple retraction dates and may be accompanied by additional retraction privileges such as increased dividend rates and conversion features.
A retraction feature that enables the shareholder to force the issuing corporation to make cash payments is often called a Hard Retraction feature. A retraction feature that enables the shareholder to convert their preferred share into another class of share, at a set price or formula, which can then simultaneously sold at or close to the original preferred share’s par value, is often called a Soft Retraction feature.
Note: Investors should consult with their income tax advisors to ensure income tax paid is minimized.
- A Conversion/Exchange (Convertible/Exchangeable preferred) feature will enable the shareholder, and possibly the issuing corporation, the right to convert the preferred share into shares of another preferred share or another share class, such as common shares. The conversion privilege will specify the share type, the conversion price and the specific conversion date. The value of the conversion privilege will depend upon the value of the underlying shares, the conversion ratio and the length of the conversion period.
Note: With regard to taxation, usually the investor’s preferred share book value is carried over to the new share class/type. In some instances the conversion can trigger a taxable disposition of the original preferred shares. An investor should consult with their income tax consultant prior to any conversion action.
- A Fixed/Floating Rate (Fixed/Floating preferred) feature describes a preferred share that initially pays a fixed annual dividend rate that will change to a floating dividend rate at a future specified date. Initially the dividend is set at a fixed rate for a set period of time, usually five years. At a specific date, the preferred share will convert from paying a fixed annual dividend rate to paying a dividend that will fluctuate from quarter to quarter. The floating dividend rate is usually based upon the Bank of Canada Prime Interest Rate, which changes at the discretion of the Bank of Canada. Some floating rate preferred shares stipulate a minimum annual dividend rate.
In addition to converting into a floating rate preferred, many Fixed/Floating Rate preferred shares offer an option to convert into a new series of Fixed Rate preferred shares that will pay an annual dividend that is a certain percentage of the yield paid on five year Government of Canada bonds. Typically, the new and old preferred shares retain the same par value and conversion does not trigger a taxable event.
- A Reset feature provides the issuer an opportunity to change the preferred share’s fixed dividend at some future date, usually every five years. Initially the preferred share will pay the investor a fixed annual dividend for a fixed period of time. Upon reaching a set “reset” date, the dividend rate will change or be reset to a new rate for the next interval of time.
For example, a preferred share may have a 5-year Rate Reset with the new dividend rate set according to a formula. One of the most common formulas for reset-preferred shares is a rate based upon the Government of Canada Yield plus an additional percentage. Most often a rate reset will occur on every fifth year anniversary from the share’s issuance.
An example is The Toronto-Dominion Bank’s 5.0% Non-Cum. 5 year Rate Reset Class A Preference Share. This share’s resets its dividend on every fifth anniversary from the issuance date. The reset formula is as follows: “The annual dividend rate will be equal to the sum of the Government of Canada Yield plus 1.96%”.
- A Floating Rate feature provides the preferred share with a dividend rate that fluctuates from dividend period to dividend period. The dividend is calculated based upon a short-term reference interest rate. For example, a basic floating rate clause in the Prospectus woud read like the following:
From February 1, 2005, floating adjustable cumulative preferred cash dividends, if declared, will be payable monthly on the twelfth day of each month following the month of February 2005, with the annual floating dividend rate for the Ñrst month equal to 80% of Prime. The dividend rate will float in relation to changes in Prime and will be adjusted upwards or downwards on a monthly basis whenever the Calculated Trading Price of the Series 15 Preferred Shares is $24.875 or less or $25.125 or more respectively. The maximum monthly adjustment for changes related to the Calculated Trading Price will be
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