trust-preferred security

A trust-preferred security is a security possessing characteristics of both equity and debt issues. A company creates trust-preferred securities by creating a trust and issuing debt to the new entity, while the trust issues the trust preferred securities. Trust-preferred securities are generally issued by bank holding companies. The security is a hybrid security with characteristics of both subordinated debt and preferred stock in that it is generally very long term (30 years or more), allows early redemption by the issuer, makes periodic fixed or variable interest payments, and matures at face value. In addition, trust preferred securities issued by bank holding companies will usually allow the deferral of interest payments for up to 5 years. The principal advantages of these hybrid characteristics are favorable tax, accounting, and credit treatment. Trust preferred securities have an additional advantage over other types of hybrid securities (such as similar types of debt issued directly to investors without the intervening trust), which is that if they are issued by a bank holding company, they will be treated as capital (equity/own funds) rather than as debt for regulatory purposes. This is why trust preferred securities are issued overwhelmingly by bank holding companies, even though any company can issue them. Trust preferred securities are used by bank holding companies for their favorable tax, accounting, and regulatory capital treatments. Specifically, these securities are taxed like debt obligations by the IRS, so interest payments are deductible. Dividends on preferred stock, by comparison, are paid out of after-tax income. The company may therefore enjoy a significantly lower cost of funding. If issued by a bank holding company, they are treated as capital rather than liabilities under banking regulations, and may be treated as the highest quality capital (tier 1 capital) if they have certain characteristics. Since the amount of liabilities (such as deposits) that a banking institution may have is limited to some multiple of its capital, this regulatory treatment is highly favorable and is why the trust preferred structure is favored by bank holding companies. Non-financial companies are more likely to use less complex structures, such as issuing junior subordinated debt directly to the public.