Trust Certificate

What Is a Trust Certificate?

A trust certificate is a bond or debt investment, usually issued by a public corporation, that is backed by other assets. These assets serve a purpose similar to collateral. That is, if the company fails to make the payments that are due, the assets may be seized and sold to help specific trust certificate holders recover a portion of their investment.

The types of company assets that are used to create a trust certificate varies, but most often are other shares of company stock shares or physical equipment.

Understanding Trust Certificates

Trust certificates offer investors a high degree of safety in comparison with unsecured or uncollateralized bonds. They also typically pay a lower level of interest than those investors willing to take greater risks.

That can be an attractive balance for conservative investors, such as retirees seeking a steady source of income.

First Check the Company's Finances

However, investing in trust certificates can be complex. It requires an understanding of a company's overall financial situation and the nature of the asset that underlies the trust certificate.

Special caution should be taken when investing in trust certificates with an underlying asset that is the same company's stock. If the company runs into financial trouble, the asset backing the trust certificate can become as worthless as the trust certificate itself.

Analyzing a Trust Certificate

Investors considering trust certificates should undertake the same financial analysis that they would devote to the company's stock.

A trust certificate is a bond, not a share of common stock, but the value and risk profile of both potential investments reflect the issuing company’s financial stability and potential for future growth. A little digging into the company’s income statement, balance sheet, and cash flow statement will yield the latest published information. Management earnings calls and industry news help investors stay on top of changes.

What Happens in a Bankruptcy

If the company goes bankrupt, its assets are distributed to lenders and shareholders in a specific order. Investors or creditors who have taken the least risk are paid first. These include those who have purchased trust certificates and other forms of secured debt.

Farther down on the list are holders of unsecured debt, which typically include banks, suppliers, and bondholders. Equity holders are paid last, if at all. Preferred shareholders must be paid before common shareholders.

Whoever is in line once the company's assets run dry may never see a penny of their investments.