Trust Preferred Securities

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Trust Preferred Securities (TruPs), are long-term instruments with early redemption features. They make quarterly fixed interest payments and mature at face value. In this regard, they are a hybrid of equity and debt instruments. Companies created TruPs and enjoy their flexibility and accounting benefits. They are an easy way for smaller banks and companies to make money.[1]

Background

TruPs grew in popularity during the financial crisis of 2008. U.S. banks sold more than $40 billion worth of TruPs. They were attractive investments because of high interest rates and a tier-one capital rating, which is viewed as a key sign of financial strength.

TruPs were also packaged into CDOs which were not set up to withstand the high levels of deferrals that happened when banks couldn't make their payments. In February of 2010, the cumulative default and deferral rate exceeded 27 percent.[2]

TruPS and the Dodd-Frank Act

In August of 2010, after the ratification of the Dodd-Frank Act, a 90-day window was opened for banks to buy back these hybrid instruments. The Act also stated that TruPs no longer count as tier one capital. Moody's estimates that in 2010, U.S. banks had $118 billion outstanding from TruPs, or about 20 percent of tier one capital at banks such as Bank of America, JP Morgan, Morgan Stanley and Citigroup.[3]

In December 2013, five regulatory agencies issued its final rules on Section 619 of Dodd-Frank, the prohibition of proprietary trading by banks, also known as the Volcker Rule. Included in the final provisions was a ban on TruPS CDOs, which meant that banks would need to divest interest in these securities. Later that month, the American Bankers Association sued the regulators on the ruling. On January 14, 2014, the agencies released an interim final rule that allowed TruPS CDO to be retained by banks, given certain conditions. [4] [5] The ABA promptly dropped their lawsuit.

References

  1. Trust Preferred Securities (TruPs). Investopedia.
  2. In CDOs we TRUPS. FT Alphaville.
  3. Wall St banks face dilemma over Dodd-Frank clause on securities. CNBC.
  4. ABA threatens to sue regulators over Volcker Rule. CNBC.
  5. Volcker Rule Block Request Dropped by Bankers Group. Bloomberg.