What Is an Income Deposit Security (IDS)?
An income deposit security (IDS) is a hybrid financial instrument that gives its owner one share of common stock and one portion of a corporate bond from the same issuer. These securities are packaged to provide regular income payments to security holders, who receive dividends from the common stock and fixed income payments from the debt instrument.
IDSs trade on exchanges and are considered to be relatively tax-efficient options for the issuer.
- An income deposit security (IDS) combines elements of common stock and a high-yielding fixed-income investment.
- Dividends from the stock portion and interest coupons from the bond portion provide investors with guaranteed income.
- Investors can split the two portions of the IDS after a certain holding period.
- Companies that issue ISDs tend to be mature corporations with stable cash flows and low capital expenses.
How Income Deposit Securities Work
Income deposit securities have been around since the early 2000s. As noted above, they provide the holder with a combination of shares in common stock with high-yielding bonds. As such, anyone who holds these securities receives dividends paid by the stock and income at regular intervals from the fixed-income portion.
Investors also benefit from the stock's potential for capital appreciation. And because the high-yield bond component is a subordinated security, the issuer pays a higher coupon than it would to someone who holds an unsubordinated note.
IDSs, which are also called income participating securities (IPSs) and enhanced income securities, are traded on stock exchanges as packaged units. The two components can be separated at a later date and traded individually. Investors are usually required to hold the combined unit for a certain period of time before they can break them up. This is usually anywhere between 45 to 90 days.
Companies that issue this type of security are usually very stable and mature, as they must be able to deliver the interest payments out of free cash flows. This means that issuing companies tend to have very stable cash flows and lower capital expenditure requirements, as higher expenses would mean the fixed-income payments would be in jeopardy.
Income deposit securities are generally also issued by companies that want to generate a tax shield. They do this by deducting the interest payments made to investors from their operating income.
Keep in mind, though, that part of the security's distribution may be deemed a return of capital rather than a dividend. This means that an investor may be charged a higher rate for this portion of income. This is usually 15%, which is the same as the rate for capital gains.
History of Income Deposit Securities
Income deposit securities have been around since the early 2000s. An innovation of Bay Street, which is the base of Canada's financial services industry, IDSs held some promise in their early days. But there are relatively few of these securities in the market today.
They were modeled after income trusts, a popular investment in Canada. These are investments whose portfolios hold assets that produce income. Distributions are paid out to shareholders at regular intervals during the year. These investments are normally managed by financial institutions and don't have any employees.
Example of an Income Deposit Security
As a historical example, B&G Foods issued these kinds of securities to its investors. They included a share of Class A common stock packaged with a 12% senior subordinated note that came due in 2016. The IDS paid a quarterly cash dividend of $0.2120 per share along with an interest payment of $0.2145 per $7.15 principal amount of the notes. Royal Bank of Canada underwrote the security.