Business, Legal & Accounting Glossary
A security possessing characteristics of both equity and debt issues. A company creates trust-preferred securities by creating a trust and issuing debt to the new entity. Because the interest paid to the trust is tax-deductible, the company may realize significant tax benefits.
Trust preferred securities (TruPS) are cumulative preferred stock issued by bank holding companies through a special purpose vehicle. For the issuing bank holding company, TruPS combine benefits of both debt and equity.
The special purpose vehicle is wholly owned by the bank holding company and is usually a trust. It sells the TruPS to investors and uses the proceeds to purchase a subordinated note from the bank holding company. This becomes its sole asset, and cash flows from the note largely mirror the dividends payable on the TruPS. The note has an initial maturity of at least 30 years. Dividends are paid quarterly or semi-annually. Dividends may be deferred for at least five years without creating an event of default or acceleration.
From a tax standpoint, TruPS have a significant advantage over the direct issuance of preferred shares. This is because dividends on preferred shares are not deductible as a business expense, but interest on a subordinated note is. In this regard, the TruPS behaves like debt. In another regard, it behaves like equity.
In 1996, the Federal Reserve ruled that up to 25% of a bank holding company’s tier 1 capital may comprise TruPS or directly issued. This helped fuel a wave of bank mergers in the early 2000s, as banks found raising capital through TruPS easier than issuing stock as a means of funding acquisitions. In 2005, the Fed reaffirmed its favourable treatment of TruPS after FASB modified the accounting treatment of TruPS under GAAP.
Initially, TruPS were only issued by larger bank holding companies. This changed in 2000 when several institutions issued TruPS, which were pooled in a CDO. TruPS were also issued by insurance holding companies and REITs. Those securities were also packaged in CDOs.
An amendment introduced by Senator Susan Collins and included in the Dodd-Frank Act is gradually phasing out the inclusion of TruPS in tier 1 capital for all but some of the smallest bank holding companies.
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This glossary post was last updated: 19th November, 2021 | 0 Views.