What Does Trust Preferred Securities Mean?
Trust preferred securities (TruPS) are securities issued by large banks and bank holding companies. The bank opens a trust which is then funded with debt. The bank then carves up shares of the trust and sells them to investors. The resulting share is called a trust preferred security, or TruPS. It is an important distinction that when an investor buys a trust preferred security they are buying a portion of the trust and its underlying holdings, not a piece of ownership in the bank itself.
The trust preferred security is considered to be preferred stock and even pays dividends on a set schedule like preferred stock. However, 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 usually offers a higher periodic payment than a share of preferred stock and can have a maturity of up to 30 years due to the long maturity timeline of the debt used to fund the trust.
Understanding Trust Preferred Securities (TruPS)
Trust preferred securities (TruPS) have been created by companies for their favorable accounting treatments and flexibility. Specifically, these securities are taxed like debt obligations by the Internal Revenue Service while maintaining the appearance of equities in a company's accounting statements as according to GAAP procedures. The issuing bank pays tax-deductible interest payments into the trust which is then distributed to the trust's shareholders.
The Dodd-Frank financial reform act passed in 2010 includes a section that calls for the phase-out of Tier 1 capital treatment of trust preferred securities issued by institutions with over $15 billion in assets by 2013. Tier 1 capital treatment means that banks can use money invested in their trust preferred securities to count towards their Tier 1 capital ratio. The Tier 1 capital ratio is the money banks keep on hand to cover losses sustained due to bad debt. The phase-out of inclusion of trust preferred securities in the Tier 1 capital ratio may increase funding requirements for some banks and in some cases reduces the number of incentives for banks to issue trust preferred securities.