Background on US TruPS

TruPS are Trust Preferred Securities, sold in the States. There’s an article on Bloomberg today with some interesting background. Note that TruPS pay interest since, if the Bush tax cuts are not extended, there is no preferential tax rate on dividends that offsets the tax on the profits paid by the issuer.

So-called community banks and larger lenders have sold trust-preferred securities, known as TruPS, for about a dozen years. Collateralized debt obligations became the biggest buyers, generating enough demand to expand the market 10-fold, according to Merrill Lynch & Co. index data. The CDOs packaged the shares and sliced them into pieces with varying credit ratings.

Community banks such as FirsTier were too small to attract insurance companies or mutual funds and sold the securities to CDOs instead, in issues of $10 million or $20 million at a time, according to Fitch Ratings analyst Nathan Flanders.

The market was upended after mortgage foreclosures reached a record high of 2.47 percent for all loans in the U.S., starting a credit-market meltdown that sent investors fleeing to safer government securities.

As the preferred market seized up, the Standard & Poor’s Small Cap Regional Banks Index has fallen 34 percent this year, leaving banks unable to sell common stock without diluting existing shareholders. Cut off from fresh capital, some lenders may file for bankruptcy, according to ICBA’s Cole.

Trust-preferred shares were attractive to banks because dividends are paid out of pre-tax income and may be suspended without penalty. The stock is considered Tier 1 capital, a lender’s most basic layer.

Only 10 banks out of about 2,000 issuers halted dividends in the seven years ending in September, and all but two resumed distribution, according to Flanders.

Since September, 23 banks, including Pasadena, California- based IndyMac Bancorp Inc. and Omni Financial Services Inc. of Atlanta, stopped making preferred-stock dividend payments. IndyMac has fallen 89 percent and Omni 81 percent this year.

About $46 billion of trust-preferred CDOs were sold since 2000, Flanders said. None has been created since November. [Fitch Ratings analyst Nathan] Flanders said May 21 that he may downgrade parts of 59 CDOs because so many banks had defaulted or deferred dividends.

Moody’s Investors Service said today that it will review all CDOs backed by bank trust-preferred securities, according to a report by analysts John Park and James Brennan.

There is a specialty US-based ETF based on TruPS, PGF trading on AMEX. As of March 31, it was down 11.54% for the prior year, vs. -11.48% for the S&P Preferred Index and -8.42% for the propietary Wachovia index it reflects.

Update: According to FRB Atlanta:

The Federal Reserve Board has amended its capital guidelines to allow bank holding companies (BHCs) to continue including trust preferred securities—commonly known as TRUPS—in their core,1 or tier 1, capital although in lesser amounts than previously permitted. By 2009, most BHCs will have to limit restricted core capital elements,2 which include TRUPS, to 25 percent of the sum of their core capital, and very large or internationally active BHCs will have to limit restricted elements to 15 percent of core capital.

TRUPS are created when a special purpose entity, which is controlled by a bank holding company, issues preferred stock. Then the controlling BHC issues debt, which the special purpose entity purchases. Interest payments on that debt provide cash flows for paying preferred stock dividends.

Thus, it is structurally equivalent to Loan-Based Innovative Tier 1 Capital.

2 Responses to “Background on US TruPS”

  1. […] I noted yesterday that the US TruPS market was being hit by a CDO buyers’ strike. This could also, indirectly, […]

  2. […] I have written a short post with some background on US TruPS. […]

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