Trust Preferred Securities (TruPS): Overview
Trust Preferred Securities (TruPS) were hybrid financial instruments issued primarily by banks and bank holding companies. They combined features of debt and equity: structured to appear as preferred stock to investors and on financial statements, while economically funded with debt whose payments were tax-deductible for the issuer.
First issued in the mid-1990s, TruPS were widely used until regulatory reforms after the 2008–09 financial crisis led to their phase-out for most large institutions.
Explore More Resources
How TruPS Worked
- A bank created a separate trust and funded it with debt issued by the bank or bank holding company.
- The trust issued preferred shares to outside investors — these shares were the TruPS.
- Investors received periodic payments that, in form, resembled preferred-stock dividends but were treated as interest on the underlying debt for tax purposes.
- The trust typically repaid principal at maturity (often up to 30 years), although many TruPS included provisions for early redemption by the issuer.
Because the trust held the debt, investors bought a claim on the trust and its cash flows, not direct ownership in the issuing bank.
Key Features
- Hybrid status: accounted for as equity (preferred stock) for regulatory and reporting purposes while economically tied to debt.
- Tax treatment: payments were generally tax-deductible for the issuer, like interest.
- Payment flexibility: periodic payments could be fixed or variable; some issues allowed payment deferrals (commonly up to five years).
- Long maturities: many issues extended up to 30 years.
- Higher yields: investors usually demanded higher returns than for comparable debt because of features such as payment deferral and subordination.
Advantages and Disadvantages
Advantages for issuers:
– Could be treated as Tier 1 capital (for a period), supporting regulatory capital ratios.
– Interest-like payments were tax-deductible.
Explore More Resources
Disadvantages:
– Costly: investors required higher yields to compensate for risks and unusual provisions.
– Complex and potentially expensive to structure and underwrite.
– Payment deferral and subordination increased perceived risk for investors.
Regulatory Changes and Phase-Out
Dodd–Frank financial reforms (2010) included provisions to phase out Tier 1 capital treatment for TruPS issued by institutions with more than $15 billion in assets. This reduced the regulatory incentive for large banks to issue TruPS and contributed to their decline. Subsequent legislative proposals and prudential rulemaking further limited the use of TruPS as regulatory capital.
Explore More Resources
Investor Considerations
- Buying TruPS means buying a preferred interest in the trust, not an equity stake in the bank itself.
- Assess risk factors such as subordination, deferral provisions, creditworthiness of the issuer, and the potential impact of regulatory changes.
- Compare yields to other fixed-income and preferred-stock alternatives, factoring in tax treatment and liquidity.
Conclusion
Trust Preferred Securities were a notable example of hybrid capital instruments that offered tax advantages and balance-sheet flexibility to banks. Regulatory reforms and changing capital rules significantly curtailed their use, especially among large institutions, leaving TruPS largely a historical instrument in contemporary banking finance.