Trust Preferred Securities (TPS) have evolved from a “big bank” concept to something suitable for community banks. The structure of TPS has changed over the years to make them affordable and available to almost any size bank.

TPS can provide a cost-effective means for increasing capital. They function like a preferred stock instrument for capital purposes but are treated like a debt instrument for tax purposes. TPS is considered Tier 1 capital for regulatory purposes (up to 25 percent of Tier 1 capital including the TPS). Payments made to TPS investors are tax deductible as “interest expense” for the issuer and treated as interest income by investors.  In general, the cost of TPS to the issuer, which needs to be a bank holding company, is less than the cost of issuing common or preferred stock.

In addition to increased Tier 1 capital and tax-deductible payments to investors, other benefits include the fact that common stock equity is not diluted, per-share financial results are often improved, and the shareholder base remains the same. Reasons for using TPS vary by entity, but in general, capital needs satisfied through TPS include: 

• Funding core growth (alternative funding source for asset growth)
• Acquisitions
• Debt reduction or restructuring
• Repurchase of common stock
• Regulatory order to increase capital

The Evolution of TPS

Initially, TPS were issued in public offerings by large banks raising large amounts of capital. The high issue amounts were necessary to offset the significant underwriting cost of the offering.

Then came “pooled” TPS offerings, allowing groups of banks to come together to share the costs associated with the public offering and reduce the required level of capital each would need to raise. Issuance costs were lower, but historically were still cost-prohibitive to smaller community banks. Pools also have underwriting criteria that some community banks may not meet. Recently, investment bankers have begun to make pools a more viable option for community banks by lowering the costs and participation requirements.

Finally, the evolution has taken TPS into the age of “private placements.” Private placements generally allow any size bank with any size capital need to take advantage of TPS (although private placement agents may also have bank “quality” parameters). The costs are a fraction of the public offering costs allowing smaller issues to make economic sense. While public and pooled issuance is generally guaranteed, private placement issuance is on a “best efforts” basis. Placement is typically not a problem for quality issuances that are properly priced. The private placement structure mirrors the public offering structure.

As the TPS market has expanded, competition has increased resulting in more narrow spreads on the pricing and lower placement fees.  For many pools there are no placement fees, with the costs instead built into the rate. Private placement fees, which previously were as high as 2%, are now 1% or less. Issuers of TPS now have alternatives and the opportunity to negotiate which did not exist in the past.

An Advantage Worth Considering

Trust Preferred Securities have been around for a number of years and through their evolution have become affordable for institutions of almost any size.  They continue to be a tool worth considering for bank holding companies in need of additional capital. With rates trending upward and the cost of capital increasing, now may be the time to consider trust preferred securities.