Preferred stock

Preferred stock (also called preferred shares, preference shares or simply preferreds) is a form of stock which may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Preferred stocks are senior (i.e., higher ranking) to common stock, but subordinate to bonds in terms of claim (or rights to their share of the assets of the company)[1] and may have priority over common stock (ordinary shares) in the payment of dividends and upon liquidation. Terms of the preferred stock are described in the issuing company's articles of association or articles of incorporation.

Like bonds, preferred stocks are rated by the major credit rating companies. The rating for preferred stocks is generally lower than for bonds because preferred dividends do not carry the same guarantees as interest payments from bonds and because preferred-stock holders' claims are junior to those of all creditors.

Features

Preferred stock is a special class of shares which may have any combination of features not possessed by common stock. The following features are usually associated with preferred stock:[2]

  • Preference in dividends.
  • Preference in assets, in the event of liquidation.
  • Convertibility to common stock.
  • Callability (ability to be redeemed before it matures), at the option of the corporation. Possibly subject to a spens clause.
  • Nonvoting.
  • Higher dividend yields.

Preference in dividends

In general, preferred stock has preference in dividend payments. The preference does not assure the payment of dividends, but the company must pay the stated dividends on preferred stock before or at the same time as any dividends on common stock.[2]

Preferred stock can be cumulative or noncumulative. A cumulative preferred requires that if a company fails to pay a dividend (or pays less than the stated rate), it must make up for it at a later time in order to ever pay common-stock dividends again. Dividends accumulate with each passed dividend period (which may be quarterly, semi-annually or annually). When a dividend is not paid in time, it has "passed"; all passed dividends on a cumulative stock make up a dividend in arrears. A stock without this feature is known as a noncumulative, or straight,[3] preferred stock; any dividends passed are lost if not declared.[4]

Other features or rights

  • Preferred stock may or may not have a fixed liquidation value (or par value) associated with it. This represents the amount of capital which was contributed to the corporation when the shares were first issued.[5]
  • Preferred stock has a claim on liquidation proceeds of a stock corporation equal to its par (or liquidation) value, unless otherwise negotiated. This claim is senior to that of common stock, which has only a residual claim.
  • Almost all preferred shares have a negotiated, fixed-dividend amount. The dividend is usually specified as a percentage of the par value or as a fixed amount (for example, Pacific Gas & Electric 6% Series A Preferred). Sometimes, dividends on preferred shares may be negotiated as floating; they may change according to a benchmark interest-rate index (such as LIBOR).
  • Some preferred shares have special voting rights to approve extraordinary events (such as the issuance of new shares or approval of the acquisition of a company) or to elect directors, but most preferred shares have no voting rights associated with them; some preferred shares gain voting rights when the preferred dividends are in arrears for a substantial time. This is all variable on the rights assigned to the preferred shares at the time of incorporation.

The above list (which includes several customary rights) is not comprehensive; preferred shares (like other legal arrangements) may specify nearly any right conceivable. Preferred shares in the U.S. normally carry a call provision,[6] enabling the issuing corporation to repurchase the share at its (usually limited) discretion.

Types

In addition to straight preferred stock, there is diversity in the preferred stock market. Additional types of preferred stock include:

  • Prior preferred stock—Many companies have different issues of preferred stock outstanding at one time; one issue is usually designated highest-priority. If the company has only enough money to meet the dividend schedule on one of the preferred issues, it makes the payments on the prior preferred. Therefore, prior preferreds have less credit risk than other preferred stocks (but usually offer a lower yield).
  • Preference preferred stock—Ranked behind a company's prior preferred stock (on a seniority basis) are its preference preferred issues. These issues receive preference over all other classes of the company's preferred (except for prior preferred). If the company issues more than one issue of preference preferred, the issues are ranked by seniority. One issue is designated first preference, the next-senior issue is the second and so on.
  • Convertible preferred stock—These are preferred issues which holders can exchange for a predetermined number of the company's common-stock shares. This exchange may occur at any time the investor chooses, regardless of the market price of the common stock. It is a one-way deal; one cannot convert the common stock back to preferred stock. A variant of this is the anti-dilutive convertible preferred recently made popular by investment banker Stan Medley who structured several variants of these preferred for some forty plus public companies. In the variants used by Stan Medley the preferred share converts to either a percentage of the company's common shares or a fixed dollar amount of common shares rather than a set number of shares of common.[7] The intention is to ameliorate the bad effects investors suffer from rampant shorting and dilutive efforts on the OTC markets.
  • Cumulative preferred stock—If the dividend is not paid, it will accumulate for future payment.
  • Exchangeable preferred stock—This type of preferred stock carries an embedded option to be exchanged for some other security.
  • Participating preferred stock—These preferred issues offer holders the opportunity to receive extra dividends if the company achieves predetermined financial goals. Investors who purchased these stocks receive their regular dividend regardless of company performance (assuming the company does well enough to make its annual dividend payments). If the company achieves predetermined sales, earnings or profitability goals, the investors receive an additional dividend.
  • Perpetual preferred stock—This type of preferred stock has no fixed date on which invested capital will be returned to the shareholder (although there are redemption privileges held by the corporation); most preferred stock is issued without a redemption date.
  • Putable preferred stock—These issues have a "put" privilege, whereby the holder may (under certain conditions) force the issuer to redeem shares.
  • Monthly income preferred stock—A combination of preferred stock and subordinated debt.
  • Non-cumulative preferred stock—Dividends for this type of preferred stock will not accumulate if they are unpaid; very common in TRuPS and bank preferred stock, since under BIS rules preferred stock must be non-cumulative if it is to be included in Tier 1 capital.[8]

Usage

Preferred stocks offer a company an alternative form of financing—for example through pension-led funding; in some cases, a company can defer dividends by going into arrears with little penalty or risk to its credit rating, however, such action could have a negative impact on the company meeting the terms of its financing contract.[9] With traditional debt, payments are required; a missed payment would put the company in default.

Occasionally companies use preferred shares as means of preventing hostile takeovers, creating preferred shares with a poison pill (or forced-exchange or conversion features) which are exercised upon a change in control. Some corporations contain provisions in their charters authorizing the issuance of preferred stock whose terms and conditions may be determined by the board of directors when issued. These "blank checks" are often used as a takeover defense; they may be assigned very high liquidation value (which must be redeemed in the event of a change of control), or may have great super-voting powers.

When a corporation goes bankrupt, there may be enough money to repay holders of preferred issues known as "senior" but not enough money for "junior" issues. Therefore, when preferred shares are first issued their governing document may contain protective provisions preventing the issuance of new preferred shares with a senior claim. Individual series of preferred shares may have a senior, pari-passu (equal), or junior relationship with other series issued by the same corporation.

Users

Preferred shares are more common in private or pre-public companies, where it is useful to distinguish between the control of and the economic interest in the company. Government regulations and the rules of stock exchanges may either encourage or discourage the issuance of publicly traded preferred shares. In many countries, banks are encouraged to issue preferred stock as a source of Tier 1 capital. On the other hand, the Tel Aviv Stock Exchange prohibits listed companies from having more than one class of capital stock.

A company may issue several classes of preferred stock. It may undergo several rounds of financing, with each round receiving separate rights and having a separate class of preferred stock. Such a company might have "Series A Preferred," "Series B Preferred," "Series C Preferred" and common stock.

In the United States there are two types of preferred stocks: straight preferreds and convertible preferreds. Straight preferreds are issued in perpetuity (although some are subject to call by the issuer, under certain conditions) and pay a stipulated dividend rate to the holder. Convertible preferreds—in addition to the foregoing features of a straight preferred—contain a provision by which the holder may convert the preferred into the common stock of the company (or, sometimes, into the common stock of an affiliated company) under certain conditions (among which may be the specification of a future date when conversion may begin, a certain number of common shares per preferred share or a certain price per share for the common stock).

There are income-tax advantages generally available to corporations investing in preferred stocks in the United States. See Dividends received deduction.

But for individuals, a straight preferred stock, a hybrid between a bond and a stock, bears some disadvantages of each type of securities without enjoying the advantages of either. Like a bond, a straight preferred does not participate in future earnings and dividend growth of the company, or growth in the price of the common stock. However, a bond has greater security than the preferred and has a maturity date at which the principal is to be repaid. Like the common, the preferred has less security protection than the bond. However, the potential increase in the market price of the common (and its dividends, paid from future growth of the company) is lacking for the preferred. One advantage of the preferred to its issuer is that the preferred receives better equity credit at rating agencies than straight debt (since it is usually perpetual). Also, certain types of preferred stock qualify as Tier 1 capital; this allows financial institutions to satisfy regulatory requirements without diluting common shareholders. Through preferred stock, financial institutions are able to gain leverage while receiving Tier 1 equity credit.

If an investor paid par ($100) today for a typical straight preferred, such an investment would give a current yield of just over six percent. If, in a few years, 10-year Treasuries were to yield more than 13 percent to maturity (as they did in 1981) these preferreds would yield at least 13 percent; since the rate of dividend is fixed, this would reduce their market price to $46, a 54-percent loss. The difference between straight preferreds and Treasuries (or any investment-grade Federal-agency or corporate bond) is that the bonds would move up to par as their maturity date approaches; however, the straight preferred (having no maturity date) might remain at these $40 levels (or lower) for a long time.

Advantages of straight preferreds may include higher yields and—in the U.S. at least—tax advantages; they yield about 2 percent more than 10-year Treasuries, rank ahead of common stock in case of bankruptcy and dividends are taxable at a maximum rate of 15% rather than at ordinary-income rates (as with bond interest).

Advantages of preference shares

  1. No obligation for dividends: A company is not bound to pay a dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preference shares also. No fixed burden is created on its finances.
  2. No interference: Generally, preference shares do not carry voting rights. Therefore, a company can raise capital without dilution of control. Equity shareholders retain exclusive control over the company.
  3. Trading on equity: The rate of dividend on preference shares is fixed. Therefore, with the rise in its earnings, the company can provide the benefits of trading on equity to the equity shareholders.
  4. No charge on assets: Preference shares do not create any mortgage or charge on the assets of the company. The company can keep its fixed assets free for raising loans in future
  5. Variety: Different types of preference shares can be issued depending on the needs of investors. Participating preference shares or convertible preference shares may be issued to attract bold and enterprising investors.

Country-by-country perspectives

Canada

Preferred shares represent a significant portion of Canadian capital markets, with over C$11.2 billion in new preferred shares issued in 2016.[10] Many Canadian issuers are financial organizations which may count capital raised in the preferred-share market as Tier 1 capital (provided that the shares issued are perpetual). Another class of issuer includes split share corporations. Investors in Canadian preferred shares are generally those who wish to hold fixed-income investments in a taxable portfolio. Preferential tax treatment of dividend income (as opposed to interest income) may, in many cases, result in a greater after-tax return than might be achieved with bonds.

Preferred shares are often used by private corporations to achieve Canadian tax objectives. For instance, the use of preferred shares can allow a business to accomplish an estate freeze. By transferring common shares in exchange for fixed-value preferred shares, business owners can allow future gains in the value of the business to accrue to others (such as a discretionary trust).

Germany

The rights of holders of preference shares in Germany are usually rather similar to those of ordinary shares, except for some dividend preference and no voting right in many topics of shareholders' meetings. Preference shares in German stock exchanges are usually indicated with V, VA or Vz (short for Vorzugsaktie)—for example, "BMW Vz"[11]—in contrast to St, StA (short for Stammaktie) or NA (short for Namensaktie) for standard shares.[12] Preference shares with multiple voting rights, e.g. at RWE or Siemens, have been abolished.

Preferred stock may comprise up to half of total equity. It is convertible into common stock, but its conversion requires approval by a majority vote at the stockholders' meeting. If the vote passes, German law requires consensus with preferred stockholders to convert their stock (which is usually encouraged by offering a one-time premium to preferred stockholders). The firm's intention to do so may arise from its financial policy (i.e. its ranking in a specific index). Industry stock indices usually do not consider preferred stock in determining the daily trading volume of a company's stock; for example, they do not qualify the company for a listing due to a low trading volume in common stocks.[12]

United Kingdom

Perpetual non-cumulative preference shares may be included as Tier 1 capital. Perpetual cumulative preferred shares are Upper Tier 2 capital. Dated preferred shares (normally having an original maturity of at least five years) may be included in Lower Tier 2 capital.[13]

United States

In the United States, the issuance of publicly listed preferred stock is generally limited to financial institutions, REITs and public utilities. Because in the U.S. dividends on preferred stock are not tax-deductible at the corporate level (in contrast to interest expense), the effective cost of capital raised by preferred stock is significantly greater than issuing the equivalent amount of debt at the same interest rate. This has led to the development of TRuPS: debt instruments with the same properties as preferred stock. With the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, TRuPS will be phased out as a vehicle for raising Tier 1 capital by bank holding companies. Outstanding TRuPS issues will be phased out completely by 2015.[14]

However, with a qualified dividend tax of 15 percent (compared to a top ordinary marginal tax rate of 35 percent),[15] $1 of dividend income taxed at this rate provides the same after-tax income as approximately $1.30 in interest. The size of the preferred stock market in the United States has been estimated as $100 billion (as of early 2008), compared to $9.5 trillion for equities and US$4.0 trillion for bonds.[16] The amount of new issuance in the United States was $34.1 billion in 2016.[17]

Other countries

  • In Nigeria preferred shares make up a small percentage of a company's stock with no voting rights except in cases were they are not paid dividends; owners of preferred shares are entitled to a greater percentage of company profits.
  • Czech Republic—Preferred stock cannot be more than 50 percent of total equity.
  • France—By a law enacted in June 2004 France allows the creation of preferred shares.
  • South Africa—Dividends from preference shares are not taxable as income when held by individuals.
  • Brazil—In Brazil, up to 50 percent of the capital stock of a company may be composed of preferred stock. The preferred stock will have at least one less right than the common stock (normally voting power), but will have a preference in receiving dividends.
  • Russia—No more than 25% of capital may be preferred stock. Voting rights are limited, but if dividends are not fully paid, shareholders obtain full voting rights.[18]

Notes

  1. ^ Drinkard, T., A Primer On Preferred Stocks,
  2. ^ a b Kieso, Donald E.; Weygandt, Jerry J. & Warfield, Terry D. (2007), Intermediate Accounting (12th ed.), New York: John Wiley & Sons, p. 738, ISBN 0-471-74955-9.
  3. ^ Drinkard T.
  4. ^ Kieso, Weygandt & Warfield 2007, p. 739.
  5. ^ Harvard Business Services, Inc. Archived 2007-02-03 at the Wayback Machine Accessed February 23, 2007
  6. ^ According to a Quantum Online table Archived 2016-05-23 at the Portuguese Web Archive
  7. ^ "Corporate Restructuring – The New Solution For Capital Raises and Survivability – Artfield Investments RD, Inc". artfieldinvestmentsrdinc.info. Archived from the original on 12 March 2013. Retrieved 29 April 2018.
  8. ^ Basel Committee on Banking Supervision [Minimum Capital Requirements "Archived copy" (PDF). Archived (PDF) from the original on 2012-02-19. Retrieved 2012-02-21.CS1 maint: Archived copy as title (link)] Accessed 2007-1-12
  9. ^ Heinkel, R. & Zechner, J. (1990), "The Role of Debt and Preferred Stock as a Solution to Adverse Investment Incentives", Journal of Financial and Quantitative Analysis, 25 (1): 1–24 [p. 2], doi:10.2307/2330885.
  10. ^ PreferredStockMarket.com Archived 2018-04-29 at the Wayback Machine
  11. ^ "eurex circular 036/07" (PDF). Frankfurt: Eurex Deutschland. 2007-02-27. p. 1. Archived (PDF) from the original on 11 August 2017. Retrieved 6 May 2010.
  12. ^ a b "Stammaktie, Vorzugsaktie, Inhaberaktie, Namensakti Die Arten von Aktien" (in German). 2004-03-24. Archived from the original on 16 August 2010. Retrieved 6 May 2010.
  13. ^ FSA Handbook, PRU 2.2 Capital resources Archived 2009-02-23 at the Wayback Machine Accessed July 31, 2006
  14. ^ "Dividend Investing - Best Dividend Paying Stocks". DividendInvestor.com. Archived from the original on 25 August 2015. Retrieved 29 April 2018.
  15. ^ CCH Incorporated Marginal and Effective Tax Rates Archived 2006-10-18 at the Wayback Machine Accessed September 18, 2006
  16. ^ Standard & Poor's "Archived copy" (PDF). Archived (PDF) from the original on 2011-06-13. Retrieved 2009-08-27.CS1 maint: Archived copy as title (link) 2009-08-27
  17. ^ PreferredStockMarket.com Archived 2016-12-29 at the Wayback Machine
  18. ^ "Федеральный закон "Об акционерных обществах" от 26.12.1995 N 208-ФЗ (последняя редакция) / КонсультантПлюс". www.consultant.ru. Archived from the original on 13 September 2017. Retrieved 29 April 2018.

External links

Auction rate security

An auction rate security (ARS) typically refers to a debt instrument (corporate or municipal bonds) with a long-term nominal maturity for which the interest rate is regularly reset through a dutch auction. Since February 2008, most such auctions have failed, and the auction market has been largely frozen. In late 2008, investment banks that had marketed and distributed auction rate securities agreed to repurchase most of them at par.

CHS Inc.

For the UK government agency also named Cenex, see Centre of Excellence for Low Carbon and Fuel Cell Technologies CHS Inc. is a Fortune 100 business owned by United States agricultural cooperatives, farmers, ranchers, and thousands of preferred stock holders. Based in Inver Grove Heights, Minnesota, it owns and operates various food processing and wholesale, farm supply, Cenex brand fuel, financial services and retail businesses, and is a co-owner of Ventura Foods, a vegetable oil processor.

It is ranked 1st on the National Cooperative Bank Co-op 100 list of mutuals and cooperatives (ranked by 2012 revenue), and 96th (by 2017 revenue) in the Fortune 500 2018 list of United States corporations.

Capital Assistance Program

The Capital Assistance Program is a U.S. Treasury program that provides capital injections in exchange for mandatory convertible preferred stock and warrants to bank holding companies.

Capital Purchase Program

The Capital Purchase Program or CPP is a preferred stock and equity warrant purchase program conducted by the US Treasury Office of Financial Stability as part of Troubled Asset Relief Program (aka, TARP). According to the first congressionally mandated oversight report published by GAO, "[TARP's] primary focus was expected to be the purchase of mortgage-backed securities (MBS) and whole loans... [but] within 2 weeks of enactment... the Treasury announced that it would make $250 billion of the $700 billion available to U.S. financial institutions through purchases of preferred stock." This followed a model initiated by the United Kingdom bank rescue package announced on October 8, 2008.Because preferred stock is similar to debt in that it gets paid before common stock, some economists have questioned whether the buying of preferred stock by the CPP will be effective in getting banks to lend. Other economist have argued that the capital purchases represent a taxpayer subsidy of unsecured creditors. A review of investor presentations and conference calls by executives of some two dozen US-based banks by the New York Times found that "few [banks] cited lending as a priority. An overwhelming majority saw the bailout program as a no-strings-attached windfall that could be used to pay down debt, acquire other businesses or invest for the future." In a letter to Congress the Director-designate of the National Economic Council Larry Summers said that the Obama administration would place tighter controls on how CPP funds could be used. In particular, the second $350 billion would include restrictions on the payment of common stock dividends and executive compensation. Professor Summers also promised greater disclosure and more attempts to tie the funds to foreclosure mitigation efforts.On January 16, 2009 the Congressional Budget Office estimated that of the first $247 billion of securities purchased represented 26 percent ($64 billion) subsidy to the banks receiving funds. In his speech on February 10, 2009, the new Secretary of the Treasury Timothy Geithner announced the Capital Assistance Program. This signaled an end to the capital purchase program.A Government Accountability Office (GAO) report from March 2012 gave further details, stating "As of January 31, 2012, the Department of the Treasury (Treasury) had received $211.5 billion from its CPP investments, exceeding the $204.9 billion it had disbursed. Of that amount, $16.7 billion remains outstanding, and most of these investments were concentrated in a relatively small number of institutions. In particular, as of January 31, 2012, 25 institutions accounted for $11.2 billion, or 67 percent, of outstanding investments. As of November 30, 2011, Treasury estimated that CPP would have a lifetime income of $13.5 billion after all institutions exited the program."

Common stock

Common stock is a form of corporate equity ownership, a type of security. The terms voting share and ordinary share are also used frequently in other parts of the world; "common stock" being primarily used in the United States. They are known as Equity shares or Ordinary shares in the UK and other Commonwealth realms. This type of share gives the stockholder the right to share in the profits of the company, and to vote on matters of corporate policy and the composition of the members of the board of directors.

It is called "common" to distinguish it from preferred stock. If both types of stock exist, common/equity stockholders usually cannot be paid dividends until all preferred/preference stock dividends are paid in full; it is possible to have common stock that has dividends that are paid alongside the preferred stock.

In the event of bankruptcy, common stock investors receive any remaining funds after bondholders, creditors (including employees), and preferred stockholders are paid. As such, common stock investors often receive nothing after a liquidation bankruptcy Chapter 7.

Common stockholders can also earn money through capital appreciation. Common shares may perform better than preferred shares or bonds over time, in part to accommodate the increased risk.

Corporate finance

Corporate finance is an area of finance that deals with sources of funding, the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value. Although it is in principle different from managerial finance which studies the financial management of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.

Correspondingly, corporate finance comprises two main sub-disciplines.Capital budgeting is concerned with the setting of criteria about which value-adding projects should receive investment funding, and whether to finance that investment with equity or debt capital. Working capital management is the management of the company's monetary funds that deal with the short-term operating balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers).

The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms "corporate finance" and "corporate financier" may be associated with transactions in which capital is raised in order to create, develop, grow or acquire businesses. Recent legal and regulatory developments in the U.S. will likely alter the makeup of the group of arrangers and financiers willing to arrange and provide financing for certain highly leveraged transactions.Financial management overlaps with the financial function of the accounting profession. However, financial accounting is the reporting of historical financial information, while financial management is concerned with the allocation of capital resources to increase a firm's value to the shareholders.

Earnings per share

Earnings per share (EPS) is the monetary value of earnings per outstanding share of common stock for a company.

In the United States, the Financial Accounting Standards Board (FASB) requires EPS information for the four major categories of the income statement: continuing operations, discontinued operations, extraordinary items, and net income.

Embedded option

An embedded option is a component of a financial bond or other security, and usually provides the bondholder or the issuer the right to take some action against the other party. There are several types of options that can be embedded into a bond. Some common types of bonds with embedded options include callable bond, puttable bond, convertible bond, extendible bond, exchangeable bond, and capped floating rate note. A bond may have several options embedded if they are not mutually exclusive.

Securities other than bonds that may have embedded options include senior equity, convertible preferred stock and exchangeable preferred stock. See Convertible security.

The valuation of these securities combines bond- or equity-valuation, as appropriate, with option pricing. For bonds here, there are two main approaches: (1) Depending on the type of option, the option price, as calculated using Black Scholes, is either added to or subtracted from the price of the "straight" bond (i.e. as if it had no optionality) and this total is then the value of the bond. (2) A bespoke "tree" (usually a lattice based short rate model) may be constructed where the option's effect is incorporated at each node in the tree, affecting either the bond price or the option price as specified; see further under bond option. Once the price has been calculated, the various yields can then be calculated for the security. Other securities with embedded derivatives are priced similarly.

Equity (finance)

In accounting, equity (or owner's equity) is the difference between the value of the assets and the value of the liabilities of something owned. It is governed by the following equation:

For example, if someone owns a car worth $15,000 (an asset), but owes $5,000 on a loan against that car (a liability), the car represents $10,000 of equity. Equity can be negative if liabilities exceed assets. Shareholders' equity (or stockholders' equity, shareholders' funds, shareholders' capital or similar terms) represents the equity of a company as divided among shareholders of common or preferred stock. Negative shareholders' equity is often referred to as a shareholders' deficit.

Alternatively, equity can also refer to a corporation's share capital (capital stock in American English). The value of the share capital depends on the corporation's future economic prospects. For a company in liquidation proceedings, the equity is that which remains after all liabilities have been paid.

Freddie Mac

The Federal Home Loan Mortgage Corporation (FHLMC), known as Freddie Mac, is a public government-sponsored enterprise (GSE), headquartered in Tysons Corner, Virginia. Freddie Mac is ranked No. 38 on the 2018 Fortune 500 list of the largest United States corporations by total revenue.The FHLMC was created in 1970 to expand the secondary market for mortgages in the US. Along with the Federal National Mortgage Association (Fannie Mae), Freddie Mac buys mortgages on the secondary market, pools them, and sells them as a mortgage-backed security to investors on the open market. This secondary mortgage market increases the supply of money available for mortgage lending and increases the money available for new home purchases. The name, "Freddie Mac", is a variant of the initialism of the company's full name that had been adopted officially for ease of identification.

On September 7, 2008, Federal Housing Finance Agency (FHFA) director James B. Lockhart III announced he had put Fannie Mae and Freddie Mac under the conservatorship of the FHFA (see Federal takeover of Fannie Mae and Freddie Mac). The action has been described as "one of the most sweeping government interventions in private financial markets in decades".Moody's gave Freddie Mac's preferred stock an investment grade rating of A1 until August 22, 2008, when Warren Buffett said publicly that both Freddie Mac and Fannie Mae had tried to attract him and others. Moody's changed the credit rating on that day to Baa3, the lowest investment-grade credit rating. Freddie's senior debt credit rating remains Aaa/AAA from each of the major rating agencies: Moody's, S&P, and Fitch.As of the start of the conservatorship, the United States Department of the Treasury had contracted to acquire US$1 billion in Freddie Mac senior preferred stock, paying at a rate of 10% per year, and the total investment may subsequently rise to as much as US$100 billion. Shares of Freddie Mac stock, however, plummeted to about one U.S. dollar on September 8, 2008, and dropped a further 50% on June 16, 2010, when the Federal Housing Finance Agency ordered the stocks delisted. In 2008, the yield on U.S Treasury securities rose in anticipation of increased U.S. federal debt. The housing market and economy eventually recovered making Freddie Mac profitable once again.

For a comprehensive list of articles discussing Freddie Mac, see Bibliography of Fannie Mae and Freddie Mac.

Liquidation preference

A liquidation preference is one of the primary economic terms of a venture finance investment in a private company. The term describes how various investors' claims on dividends or on other distributions are queued and covered. Liquidation preference establishes that certain investors receive their investment money back first before other company owners in the event the company is sold, has a public offering, pays dividends, or has another liquidation (payout) event.

Mezzanine capital

In finance, mezzanine capital is any subordinated debt or preferred equity instrument that represents a claim on a company's assets which is senior only to that of the common shares. Mezzanine financings can be structured either as debt (typically an unsecured and subordinated note) or preferred stock.

Mezzanine capital is often a more expensive financing source for a company than secured debt or senior debt. The higher cost of capital associated with mezzanine financings is the result of its being an unsecured, subordinated (or junior) obligation in a company's capital structure (i.e., in the event of default, the mezzanine financing is only repaid after all senior obligations have been satisfied). Additionally, mezzanine financings, which are usually private placements, are often used by smaller companies and may involve greater overall levels of leverage than issues in the high-yield market; they thus involve additional risk. In compensation for the increased risk, mezzanine debt holders require a higher return for their investment than secured or more senior lenders.

Monthly income preferred stock

Monthly income preferred stock or MIPS is a hybrid security created by Eli Jacobson, a Sullivan & Cromwell tax partner, and introduced to the market by Goldman Sachs in 1993. In essence, MIPS is a combination of deeply subordinated debt and preferred stock.

MIPS is structured in such a way as to make payments on the security an interest expense for the borrower and dividend for the lender. A special purpose entity of the issuer sells the preferred stock to the public and then lends the proceeds to the parent. The parent's interest payments to the subsidiary are tax-deductible as interest and are used by the SPE to pay preferred dividends to the investors. However, the interest income received by the SPE is not taxable income, because it is organized as a tax-free entity.

Because of these features, MIPS at one point dominated the market for traditional perpetual preferred equity, accounting for over 70% of all new preferred issues. However, MIPS as a tax shelter no longer works. The credit rating agencies consider MIPS to be preferred stock.

Participating preferred stock

Participating preferred stock is preferred stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of a liquidation. This form of financing is used by private equity investors and venture capital firms. Holders of participating preferred stock get both their money back (with interest) and the money that is distributable with respect to the percentage of common shares into which their preferred stock can convert.

Like common stock, preferred stocks represent partial ownership in a company. Preferred stock shareholders may or may not enjoy any of the voting rights of those holding common stock. Also, unlike common stock, a preferred stock pays a fixed dividend that does not fluctuate. Often the dividend is cumulative. Thus, the company must pay all unpaid preferred dividends accumulated during previous periods before it can pay dividends to common shareholders. If the company is unable to pay this dividend, the preferred shareholders may have the right to force a liquidation of the company.

Participating preferred is often used as a "bridge" between a company that desires a higher valuation and a VC that believes in a lower valuation. A V C will agree to a higher valuation if it is accompanied by a participating preferred security—essentially challenging the company to earn the upside of the higher valuation.

The main benefit to owning preferred stock is that the investor has a greater claim on the company’s assets than common stockholders. Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before the holders of common stock. In general, there are five different types of preferred stock: cumulative preferred, non-cumulative, participating, convertible, and callable.

Post-money valuation

Post-money valuation is a way of expressing the value of a company after an investment has been made. This value is equal to the sum of the pre-money valuation and the amount of new equity.These valuations are used to express how much ownership external investors, such as venture capitalists and angel investors, receive when they make a cash injection into a company. The amount external investors invest into a company is equal to the company's post-money valuation multiplied by the fraction of the company those investors own after the investment. Equivalently, the implied post-money valuation is calculated as the dollar amount of investment divided by the equity stake gained in an investment.

More specifically, the post-money valuation of a financial investment deal is given by the formula

P

M

V

=

N

×

P

{\textstyle PMV=N\times P}

, where PMV is the post-money valuation, N is the number of shares the company has after the investment, and P is the price per share at which the investment was made. This formula is similar to the market capitalization formula used to express the value of public companies.

Private investment in public equity

A private investment in public equity, often called a PIPE deal, involves the selling of publicly traded common shares or some form of preferred stock or convertible security to private investors. It is an allocation of shares in a public company not through a public offering in a stock exchange. PIPE deals are part of the primary market. In the U.S., a PIPE offering may be registered with the Securities and Exchange Commission on a registration statement or may be completed as an unregistered private placement.

Return on tangible equity

Return on tangible equity (ROTE) (also return on average tangible common shareholders' equity) measures the rate of return on the tangible common equity.

ROTE is computed by dividing net earnings (or annualized net earnings for annualized ROTE) applicable to common shareholders by average monthly tangible common shareholders' equity. Tangible common shareholders' equity equals total shareholders' equity less preferred stock, goodwill, and identifiable intangible assets.

Series A round

A series A round is the name typically given to a company's first significant round of venture capital financing. The name refers to the class of preferred stock sold to investors in exchange for their investment. It is usually the first series of stock after the common stock and common stock options issued to company founders, employees, friends and family and angel investors.

Stock

The stock (also capital stock) of a corporation is all of the shares into which ownership of the corporation is divided. In American English, the shares are commonly known as "stocks." A single share of the stock represents fractional ownership of the corporation in proportion to the total number of shares. This typically entitles the stockholder to that fraction of the company's earnings, proceeds from liquidation of assets (after discharge of all senior claims such as secured and unsecured debt), or voting power, often dividing these up in proportion to the amount of money each stockholder has invested. Not all stock is necessarily equal, as certain classes of stock may be issued for example without voting rights, with enhanced voting rights, or with a certain priority to receive profits or liquidation proceeds before or after other classes of shareholders.

Stock can be bought and sold privately or on stock exchanges, and such transactions are typically heavily regulated by governments to prevent fraud, protect investors, and benefit the larger economy. As new shares are issued by a company, the ownership and rights of existing shareholders are diluted in return for cash to sustain or grow the business. Companies can also buy back stock, which often lets investors recoup the initial investment plus capital gains from subsequent rises in stock price. Stock options, issued by many companies as part of employee compensation, do not represent ownership, but represent the right to buy ownership at a future time at a specified price. This would represent a windfall to the employees if the option is exercised when the market price is higher than the promised price, since if they immediately sold the stock they would keep the difference (minus taxes).

Types of markets
Types of stocks
Share capital
Participants
Exchanges
Stock valuation
Trading theories
and strategies
Related terms
Capital structure
Transactions
(terms/conditions)
Valuation

This page is based on a Wikipedia article written by authors (here).
Text is available under the CC BY-SA 3.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.