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Trust Preferred Securities (TruPS)



Definition

Trust Preferred Securities (TruPS) are hybrid financial instruments that possess characteristics of both equity and debt. They are typically issued by a special purpose entity related to a parent corporation, and the proceeds are then used to purchase debt issued by that parent corporation. TruPS pay periodic interest and have long-term, often 30 years or more, maturity dates, but the issuer can typically call them after five years.

Phonetic

The phonetics of the keyword: Trust Preferred Securities (TruPS) are -Trust: /trəst/Preferred: /prɪˈfəːd/Securities: /sɪˈkjʊrɪtiːz/TruPS: /truːps/

Key Takeaways

  1. Hybrid Characteristic: Trust Preferred Securities (TruPS) are hybrid securities that combine features of debt and equity securities. They are issued by banks or corporations and can get classified as junior debt instruments. However, they possess characteristics of equity since they possess a long maturity period, often 30 years, and interest payments can be deferred.
  2. Tax Benefits: They offer potential tax benefits to the issuer. The dividends paid on TruPS can be deducted as interest expense, reducing the taxable income of the issuing company. This makes TruPS an attractive fundraising tool for corporations looking for tax-effective means of raising capitals.
  3. Risk factors: Although TruPS bear some resemblance to bonds due to its income yielding nature, investors need to understand that they entail significant risk. They are deeply subordinated, meaning they rank lower than other types of debt in terms of claim on assets. Therefore, in case of bankruptcy, they are among the last to be paid. Moreover, the issuer has the ability to defer coupon payments for up to 5 years, posing additional risks to investors.

Importance

Trust Preferred Securities (TruPS) are important because they combine features of debt and equity, providing a significant source of tier 1 capital for corporations, notably banks. They offer the advantages of both debt – in the form of tax-deductible interest, and equity – as it is a non-amortizing, long-term capital that can absorb losses. TruPS often have a long lifetime, usually about 30 years, and afford companies the option to defer interest payments for up to five years if financial hardship arises, enhancing the company’s ability to manage capital and liquidity. Thus, TruPS are a crucial funding tool in the business/ finance sphere.

Explanation

Trust Preferred Securities (TruPS) serve a unique purpose in the financial strategy of several corporations, largely financial institutions. TruPS function as an innovative tool for corporations seeking a blend of equity and debt financing. They attract investors with appealing features of both fixed periodic income, similar to bonds, and long-term expiration periods akin to stocks. The securities are issued by a special purpose entity or trust subsidiary, which allows the parent corporation to enjoy tax deductions on the distributed interest, thereby enhancing tax efficiency.TruPS are particularly useful for banking corporations due to specific regulatory considerations. Prior to the financial crisis of 2008, banking institutions utilized TruPS as a tool to beef up their Tier 1 capital without diluting equity stake, following their classification as supplementary capital by banking regulations. However, the Dodd-Frank Act of 2010 revoked this capital-status, thus undermining the appeal of TruPS for banking institutions. Nevertheless, they are still issued by predominantly insurance companies and REITs that can utilize the hybrid financial instrument’s advantageous tax structures.

Examples

1. Bank of America TruPS: In 2011, Bank of America Corporation announced that it would redeem approximately $3.9 billion in TruPS. This move was essentially to enhance the bank’s capital levels, as, under the Dodd-Frank Wall Street Reform Act, Trust Preferred Securities were phased out from Tier 1 capital status over a three-year time period.2. Citigroup’s TruP CDOs: Citigroup was involved in a major litigation concerning TruPS collateralized debt obligations (CDOs) in which the bank had to pay 7 billion dollars in 2014 as a part of a settlement following the financial crisis. Citigroup had pooled various tranches of Trust Preferred Securities and sold them as CDOs.3. Goldman Sachs issued TruPs: Goldman Sachs is another large financial institution that has issued Trust Preferred Securities in the past. In 2002, for example, they issued $1.5 billion worth of TruPs to boost their Tier 1 capital. However, since regulatory changes following the financial crisis, TruPs no longer count towards Tier 1 capital, and many companies like Goldman Sachs have redeemed or phased out their TruPs.

Frequently Asked Questions(FAQ)

What are Trust Preferred Securities (TruPS)?

Trust Preferred Securities, also known as TruPS, are stocks that combine the features of equity and debt instruments. They are issued by a bank’s parent company but are considered to be deeply subordinated debt of the bank.

How do Trust Preferred Securities (TruPS) work?

TruPS are issued via a trust, and they typically pay quarterly or semi-annual income to their holders. They have a long-term maturity, usually between 30 to 50 years, and entitle holders to a stated interest rate rather than a dividend.

What are the benefits of Trust Preferred Securities (TruPS) to investors?

From an investor’s perspective, TruPs can offer regular income flows comparable to dividends. Furthermore, because they are considered debt of the issuing bank, they usually have a superior claim to company assets compared to common share holders in the event of a bankruptcy/liquidation.

What are the benefits of issuing Trust Preferred Securities (TruPS) for companies?

For companies, TruPS can serve as a cost-effective way of raising capital as the interest payments made to investors are tax-deductible. Also, since TruPS are considered a form of debt, issuing them does not dilute the ownership interest of existing shareholders.

Are Trust Preferred Securities (TruPS) riskier than common stocks?

TruPS can be riskier than common stocks because if the issuing company encounters financial difficulty and fails to make interest payments, it could potentially default on the TruPS. However, if the company does go bankrupt, TruPS holders usually have a superior claim to the company’s assets than common shareholders.

Can Trust Preferred Securities (TruPS) be called or redeemed?

Yes, many TruPS are callable, meaning the issuing company can choose to repurchase them after a certain period, typically 5-10 years. When a TruPS is called, the investor will receive the face value of the TruPS and may also receive any unpaid interest.

Where can you purchase Trust Preferred Securities (TruPS)?

TruPS can be purchased either directly from the issuer at the time of the initial offering or on the secondary market from other investors. They are typically traded in the same manner as common stocks on securities exchanges.

Are there any potential tax advantages to owning Trust Preferred Securities (TruPS)?

Yes, unlike common stock dividends, the interest paid out on TruPS is often deductible for the company, which can potentially lead to tax advantages for some investors. However, the specific tax situation can depend greatly on individual circumstances, so it is always advisable to consult with a tax advisor.

Related Finance Terms

  • Debt Instruments
  • Junior Subordinated Debt
  • Interest Deferral
  • Tier 1 Capital
  • Maturities

Sources for More Information


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