Trust Preferred Securities Trust Preferred Securities are cumulative preferred stock issued by a business trust that is wholly owned by a bank holding company (BHC) to increase the company's capital. When originally created in 1993, this security could be classified as debt or equity, as needed, by the issuing company. However, in 2003, the Financial Accounting Standards Board issued Statement No. 150 to standardize classification of Trust Preferred Securities (TPS). A Trust Subsidiary would issue mandatorily redeemable, non-voting preferred stock to 3 rd party investors. The Trust subsidiary would then "loan" the proceeds from the sale of the stock to the Parent BHC with the debt having the same terms as the TPS.
Finally, when the Parent BHC made "interest payments" on the debt to the Trust Subsidiary, the latter used the "interest income" to make the dividend payments on the securities. For tax purposes, the Parent BHC would classify the proceeds from the issuance of the stock as debt. Remember that the proceeds of the stock issuance had been passed on to the Parent BHC as a "loan." This allowed the Parent BHC to take an "interest" expense tax deduction on the "interest" paid to the trust. The trust, however, would not get taxed on the "interest" income it received from the parent company because the trust had been established as a pass-through entity.
That means the "interest" income passed through the trust untaxed and, instead, would get taxed at the security holders' level. At the same time, for financial reporting purposes, the Parent BHC would classify the same proceeds from the sale of the TPS as capital. The problem with treating the securities as capital in financial reports was that, because the securities were mandatorily redeemable, the company had an unconditional obligation to, at some point, pay out the principal and quarterly dividends at a specified rate. Thus, classifying what met all the characteristics of debt as capital made the company's financial statements extremely misleading.
In May 2003, the Financial Accounting Standards Board issued Statement No. 150, which states that an issuer must classify as debt in the financial statements:" a financial instrument issued in the form of shares that is mandatorily redeemable, thus representing an unconditional obligation to the issuer to redeem the instrument by transferring its assets at a specified or determinable date or upon a future event." Now, TPS need to be classified as debt, not only for tax purposes, but also for financial reporting purposes.