Adjustable-Rate Preferred Stock (ARPS)

What Is Adjustable-Rate Preferred Stock (ARPS)?

Adjustable-rate preferred stock (ARPS) is a type of preferred stock where the dividends issued will fluctuate with a benchmark, most often a T-bill rate. The value of the dividend from the preferred share is set by a predetermined formula to move with rates, and in light of this flexibility preferred prices are often more stable than fixed-rate preferred stocks.

Understanding Adjustable-Rate Preferred Stock (ARPS)

The preferred category of stocks is often viewed as safer than common shares as they will be one of the first of the equity holders to receive dividend payments in the event of the company's liquidation. There is often a limit to the amount the rate can change on the dividend, adding further security to the issue. Likewise, adjustable preferred shares have dividends that periodically reset to match winning interest rates or other money market rates, for the most part on a quarterly basis.

The stability of the market value of adjustable preferred stocks, with respect to dividends payouts, makes these securities extremely attractive to conservative investors who are searching for solid income sources as well as the preservation of their capital.

Special Considerations

Adjustable preferred stocks share most of similar potential gains and drawbacks associated with non-adjustable, or "fixed-rate" preferred stocks. In both cases, corporations must first pay out dividends to preferred stockholders, before paying out dividends to common stock shareholders. But there are a few key differences between adjustable preferred stocks and their non-adjustable counterparts.

There are likewise a few negatives ramifications associated with adjustable preferred stock dividend rates. In particular, since adjustable preferred stock dividend rates are tied to a specific reference interest rate or index when the reference rate falls, so does the APS dividend rate. Consequently, an investor would receive more modest dividend payouts, and the price of the stock shows little change with these securities, dissimilar to fixed-rate preferred stocks, whose prices rise when interest rates decline.

Limits In-Place

Adjustable preferred stocks have set parameters called "collars," which are essentially caps and floors put on dividend yields. A floor — the base dividend yield an APS will payout, holds strong, even on the off chance that interest rates drop below the floor figure. Contrarily, a cap limits the maximum dividend yield payout. Naturally, investors like floors and abhorrence caps. Adjustable preferred stocks act in basically the same manner to fixed-rate preferred stocks when interest rates fall on the other side of the collar range.

Auction-Rate ARPS

A few adjustable preferred stocks utilize periodic auctions to reset dividend yield, where current and potential shareholders participate in an auction that guarantees that APS dividend yields reflect the current requirements of investors. Auction market preferred stocks have interest rates or dividends that are periodically reset through Dutch auctions.

Interest-rate auctions available to be purchased rate securities, in any case, started to fail during the 2008 financial crisis. The auctions attracted too couple of bidders to establish a clearing rate, and these dislocations resulted in high or "penalty" interest rates on those securities as well as an inability of investors to sell their auction-rate securities.

The auction-rate securities market collapsed in February 2008 when lead underwriters decided not to step in to support the auctions. For investors, this meant that they were left with illiquid investments. Since the collapse of the auction-rate securities market, the U.S. Securities and Exchange Commission, Financial Investment Regulatory Authority, and state attorneys general have arrived at settlements with major representative vendors and other entities. These settlements included agreements to buy back auction-rate securities from certain investors.

Highlights

• Adjustable-rate preferred stock (ARPS) is a way that a company can issue preferred shares whose dividends float with some benchmark interest rate like U.S. T-bills.
• Preferred stockholders have characteristics of both bonds and equity shares, and have a higher claim on distributions (for example dividends) than common stockholders.
• One risk to ARPS is that preferred shareholders will see their dividend payments decline assuming interest rates fall.