Advantages and Disadvantages of Trust Preferred Securities

Trust preferred securities are a type of security that can be issued by a company in order to raise money. This type of arrangement provides the company with several benefits. At the same time, there are a few drawbacks to be aware of as well. Here are some of the advantages and disadvantages of trust preferred securities.

Trust Preferred Securities

Trust preferred securities are an instrument that works like a hybrid of debt and equity. With this arrangement, a company will set up a trust and take ownership of 100% of the common stock. They will then distribute preferred stock to the investors. The company will pay regular interest payments to the investors. Investors can cash in the security at any point and they will be able to get face value for it at the end of the term. 

Advantages

One of the big advantages of this type of security is that it provides a company with some tax advantages. With a trust preferred security, the company is going to get to treat it like debt. When a company has debt, they get to deduct the amount of interest that they are paying to investors. This provides them with a sizable tax deduction at the end of the year. In addition to this, the company can pay for the dividends to the shareholders with after-tax income. This provides them with some significant savings when it comes to the cost of funding this process.

If the company that issues this type of security is a bank or holding company, there are some other advantages that they will be able to realize. The money that they generate from this security can count as Tier 1 capital. With banks, the amount of money that they can take in through deposits is limited to the amount and quality of the capital that they have on hand. Therefore, by issuing these securities, the band is going to be able to take on more deposits and grow the business even more. 

Disadvantages

Even though these securities do have several benefits, there are a few potential disadvantages that you will need to be aware of. One of the biggest disadvantages is that these securities cost a lot of money to issue. When issued, the company that issues them has to pay a higher interest rate than they would for other types of debt. The reason behind this is that this type of debt is subordinated behind other types of debt. Since investors are taking a bigger risk of losing their capital because of this, they are going to require a higher interest rate. 

In addition to the high interest rates, the cost to set up this type of security is high as well. The company is going to have to pay a bank to sell the securities to the public. They will also have to pay to set up the trust and to handle all of the administrative tasks.

 

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