Capital treatment of trust preferred securities changes.

The Federal Reserve Board has amended its capital guidelines to allow bank holding companies (BHCs) to continue including trust preferred securities--commonly known as TRUPS--in their core,1 or tier 1, capital although in lesser amounts than previously permitted. By 2009, most BHCs will have to limit restricted core capital elements,2 which include TRUPS, to 25 percent of the sum of their core capital, and very large or internationally active BHCs will have to limit restricted elements to 15 percent of core capital.

TRUPS spelled out

TRUPS are created when a special purpose entity, which is controlled by a bank holding company, issues preferred stock. Then the controlling BHC issues debt, which the special purpose entity purchases. Interest payments on that debt provide cash flows for paying preferred stock dividends.

TRUPS' appeal to BHCs is twofold. First, for tax purposes TRUPS are debt, so BHCs can deduct the interest they pay on TRUPS from their income. Second, for regulatory purposes TRUPS are treated as equity and therefore count toward institutions' required capital. In addition, BHCs can issue TRUPS as part of a larger pool 3 of preferred securities, which provides smaller, community BHCs an affordable means of raising capital.

Securities retain their advantage

Not long ago, BHCs with TRUPS were concerned that bank regulators would make the capital treatment of TRUPS less favorable. But the Fed's March 2005 issuance of its new risk-based capital standards eased those concerns. These new standards conform to recent changes to the 1998 amendments to the Basel banking accords yet allow continued access to capital markets by community BHCs.