Trust preferred securities (TruPS) are cumulative preferred stock issued by bank holding companies through a special purpose vehicle. For the issuing bank holding company, TruPS combine benefits of both debt and equity. The special purpose vehicle is wholly owned by the bank holding company and is usually a trust. It sells the TruPS to investors and uses the proceeds to purchase a subordinated note from the bank holding company. This becomes its sole asset, and cash flows from the note largely mirror the dividends payable on the TruPS. The note has an initial maturity of at least 30 years. Dividends are paid quarterly or semi-annually. Dividends may be deferred for at least five years without creating an event of default or acceleration.
From a tax standpoint, TruPS have a significant advantage
over the direct issuance of preferred shares. This is because dividends on
preferred shares are not deductible as a business expense, but interest on
a subordinated note is. In this regard, the TruPS behaves like debt. In
another regard, it behaves like equity. In 1996, the
Federal
Reserve ruled that up to 25% of a bank holding companies
tier 1
capital may comprise
TruPS or directly-issued
Initially, TruPS were only issued by larger bank holding companies. This changed in 2000, when several institutions issued TruPS, which were pooled in a CDO. Since then, the TruPS CDO market has grown dramatically and has become a significant source of capital for small and medium sized bank holding companies. TruPS are also issued by insurance holding companies and REITS. Those securities have also been packaged in CDOs.
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. In 2005, the Fed reaffirmed this
treatment of TruPS after FASB modified the accounting treatment of TruPS
under GAAP.
