Trust Preferred Securities (TruPS)

What Were Trust Preferred Securities (TruPS)?

Trust preferred securities (TruPS) were hybrid securities issued by large banks and bank holding companies (BHCs) remembered for regulatory tier 1 capital and whose dividend payments were tax deductible for the issuer.

The bank would open a trust funded with debt; then, the bank would cut up shares of the trust and sold them to investors as preferred stock. The subsequent stock was called a trust preferred security or TruPS.

First issued in 1996, TruPS turned into the subject of increased regulatory examination following the 2008-09 financial crisis. Because of the Dodd-Frank reforms and the Volcker Rule, the greater part of these were phased out at year-end 2015.

Understanding Trust Preferred Securities (TruPS)

The trust preferred security has characteristics of both stock and debt. While the trust is funded with debt, the shares issued are viewed as preferred stock and even pay dividends like preferred stock. In any case, since the trust holds the bank's debt as the funding vehicle, the payments the investors receive are actually interest payments and are taxed as such by the IRS.

The trust preferred security as a rule offers a higher periodic payment than a share of preferred stock and can have a maturity of as long as 30 years due to the long maturity timetable of the debt used to fund the trust. The payments to stockholders can be on a fixed schedule or variable. Likewise, a portion of the provisions in trust preferred securities can consider the deferral of interest payments for as long as five years. The TruPS develops at face value toward the end of the term, however there is the potential for early redemption in the event that the issuer so decides.

Trust preferred securities have been made by companies for their ideal accounting treatments and flexibility. In particular, these securities are taxed like debt obligations by the Internal Revenue Service while keeping up with the presence of equities in an organization's accounting statements, as per GAAP procedures. The responsible bank pays tax-deductible interest payments into the trust, which is then distributed to the trust's shareholders.

It is an important differentiation that, while buying a trust preferred security, the investor is buying a portion of the trust and its underlying holdings, not a piece of ownership in the bank itself.

Special Considerations

The Dodd-Frank financial reform act, passed in 2010, incorporated a section that called for the stage out of Tier 1 capital treatment of trust preferred securities issued by institutions with more than $15 billion in assets by 2013. Tier 1 capital treatment means that banks can utilize the money invested in their trust preferred securities to count towards their Tier 1 capital ratio, which is the money banks keep close by to cover losses supported due to terrible debt.

Getting rid of or excluding trust preferred securities in the Tier 1 capital ratio increments funding requirements for banks and, at times, diminishing the number of incentives for banks to issue trust preferred securities. The purported "Collins Amendment" was proposed in the U.S. Senate to dispose of trust preferred securities as Tier 1 regulatory capital by and large.

At last, the costs are among the inconveniences for companies giving trust preferred securities in light of the fact that the trusts now and again have highlights like deferral of interest payments and early redemption of shares. These subtleties make them less attractive to investors and, hence, the rates on trust preferred securities are ordinarily higher than those offered on different types of debt, basically investors demand a greater rate of return. The costs of investment banking fees for underwriting the securities can be strong too.

Features

• Trust preferred securities were a type of bank-issued security with characteristics of both debt and stock.
• The trust preferred security ordinarily offers a higher periodic payment than preferred stock and can have a maturity of as long as 30 years.
• They have largely been phased out by legal and regulatory action following the 2008-09 financial crisis.
• An inconvenience of TruPS for the issuer is the cost, as investors demand higher returns for investments with provisions like deferral of interest payments or early redemption.
• Issued by banks or bank holding companies by giving debt, TruPS are shares of preferred stock of a trust.