Income investors are constantly on the lookout for high-yielding investments. Preferred stocks pay dividends in the 4 percent to 8 percent range, but trust preferred securities -- TRuPS -- can pay even higher amounts. Though investors refer to both as preferred securities, they differ in several ways.
Corporations issue preferred shares as equity -- part of the ownership structure of the company. While some preferred stock carries a maturity date, most issues are perpetual. TRuPS are actually debt instruments masquerading as stock. A company creates a trust and issues a bond to that trust. The trust then issues TRuPS to the public, backed by the interest income the trust receives from the bond. TRuPS carry a maturity date, typically 30 years after issue, and are always callable -- the issuer can forcibly redeem them for a set price. Many, but not all, preferred shares are also callable.
Most preferred share dividends qualify for long-term capital gains rates. In 2013, those rates are 20 percent, 15 percent or 0 percent, depending on your taxable income. Preferred dividends are post-tax to the issuer -- the corporation cannot deduct the dividend payments from taxable income. TRuPS pay interest quarterly, taxable at your marginal bracket. The issuer can deduct the interest payments from taxable income. Of course, if you hold your TRuPS in an individual retirement account, you can defer or avoid taxes on the interest.
If a corporation goes bankrupt or defaults on its bonds, bondholders may liquidate the company to recoup their debt. TRuPS are subordinated debt, meaning holders are at the back of the line when creditors collect the liquidation proceeds. However, preferred shareholders are even further back, and common stockholders are barely visible on the horizon.
At one time, bank holding companies could use TRuPS to help satisfy their capital requirements -- the amount of cash and negotiable securities they must keep on hand at all times. This is why banks were the primary issuers of TRuPS. The Dodd-Frank financial reform legislation ended the use of TRuPS to meet capital requirements as of 2013. This change triggered a provision in some TRuPS contracts that allows the issuer to call shares before the stated call date. Regular preferred shares are never callable before the call date.
Corporations commonly issue preferred shares with a face value of $100 each. TRuPS normally carry a face value of $25 per share.
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