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Trust Preferred Securities

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Essay title: Trust Preferred Securities

Trust Preferred Securities

Trust Preferred Securities are cumulative preferred stock issued by a business trust that is wholly owned by a bank holding company (BHC) to increase the company’s capital. When originally created in 1993, this security could be classified as debt or equity, as needed, by the issuing company. However, in 2003, the Financial Accounting Standards Board issued Statement No. 150 to standardize classification of Trust Preferred Securities (TPS).

A Trust Subsidiary would issue mandatorily redeemable, non-voting preferred stock to 3rd party investors. The Trust subsidiary would then “loan” the proceeds from the sale of the stock to the Parent BHC with the debt having the same terms as the TPS. Finally, when the Parent BHC made “interest payments” on the debt to the Trust Subsidiary, the latter used the “interest income” to make the dividend payments on the securities.

For tax purposes, the Parent BHC would classify the proceeds from the issuance of the stock as debt. Remember that the proceeds of the stock issuance had been passed on to the Parent BHC as a “loan.” This allowed the Parent BHC to take an “interest” expense tax deduction on the “interest” paid to the trust. The trust, however, would not get taxed on the “interest” income it received from the parent company because the trust had been established as a pass-through entity. That means the “interest” income passed through the trust untaxed and, instead, would get taxed at the security holders’ level.

At the same time, for financial reporting purposes, the Parent BHC would classify the same proceeds from the sale of the TPS as capital. The

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