Preferred Securities

Page 1 of 2 Preferred securities

Preferred securities combine elements Preferred stock features Trust preferreds of both stocks and bonds, and while • Ranks senior to common stock, but In the early 1990s, financial institutions holders of preferred securities are junior to debt in a company’s capital began to issue a variation of preferred higher in the capital structure than structure. stock that rapidly became popular with common shareholders, they do not • Pays dividends at a stated rate, either retail investors. Recognition that these generally have the right to vote in a as a percent of par value or a specific securities all share common features company’s affairs. The main types of dollar amount. led to a generic label to cover them all: preferred securities are traditional Trust Preferred Securities (TruPS). preferred stock, trust preferred • Preferred stock is perpetual, meaning securities, notes/senior notes and it does not have a maturity date. These securities have been attractive to adjustable rate preferreds. • Dividends are either cumulative (any income-oriented investors, while also dividends not paid accumulate and creating a cost-efficient source of capital Preferred stock must be paid before dividends are for issuers. An important advantage Originally, most preferred stock paid on common stock) or non- for the issuer is that periodic payments purchasers were corporations, which cumulative. on trust preferreds are tax deductible, enjoy special tax advantages as they • Preferred stockholders do not just like interest payments on debt are allowed to exclude a percentage typically have voting rights except securities. of preferred dividends from income. under certain circumstances. Recently, however, more individual Trust Preferreds are considered • Preferred shareholders do not have investors have begun purchasing subordinated junior debentures, senior the same rights as debt holders and to common and preferred stock in preferred stocks to earn the higher cannot initiate legal action against payment priority, but behind other dividends paid compared to common the issuer in case of a failure to pay debt. Trust Preferreds are not bonds; stock, as well as to benefit from recent (defer) dividends. changes in federal tax laws. they fall between a stock and a bond • Par value on preferreds is generally in terms of right to payment. In other The Jobs and Growth Tax Relief $25. words, interest on bonds must be Reconciliation Act of 2003 introduced • Preferreds feature a degree of price paid before the interest is paid to trust a new category of qualified dividend stability compared to common stock Preferred holders, which must be paid income taxable at federal rates of 20% as a result of the fixed dividend before dividends are paid to common for those in the highest tax bracket payment. stockholders. To the individual investor, (or 0% for taxpayers in the lowest they are attractive because they offer tax bracket). These securities are Because these issues do have a fixed higher coupon rates, since the issuer often referred as to offering Qualified dividend, most feature a call date, which can pass on cost savings to investors. Dividend Income (QDI). allows the issuer to retire the preferred Trust preferreds do not qualify for the shares when interest rates decline. Dividends Received Deduction (DRD), which is a dividend exclusion feature

Investment and insurance products offered through RBC Wealth Management are not insured by the FDIC or any other federal government agency, are not deposits or other obligations of, or guaranteed by, a bank or any bank affiliate, and are subject to investment risks, including possible loss of the principal amount invested. Page 2 of 2 Preferred securities, continued available to corporate investors, or QDI deferred interest, the security holder for individual investors. would not owe any additional taxes on the deferred payments received. The Dodd-Frank Wall Street Reform • Most Trust Preferreds feature a and Consumer Protection Act passed in “special event” redemption option. 2010 eliminated the inclusion of Trust This feature allows the issuer to Preferreds from Tier 1 capital for banks redeem the securities at par plus with total assets greater than $15 billion. accrued interest in the event of a tax The Tier 1 treatment will begin to be law change, which would prohibit phased out in 2013, and will be phased deductibility of the interest payments. out by the end of 2018. As a result, • They are easily bought and sold since banks could call their hybrid and trust they are traditionally listed on the preferreds at some point during that major stock exchanges. time-frame.

Trust Preferred features Notes/senior notes Some issuers prefer to issue $25 • Usually issued in $25 face amounts par notes or senior notes which pay and typically pay a fixed coupon rate. Ranks senior to common stock, but quarterly interest and rank above trust junior to debt in a company’s capital preferreds. These issues would rank structure. equally with their bond counterparts in the capital structure. • Trust Preferreds are issued in maturities of 30 to 60 years. Some Adjustable rate preferred give the issuer the right to extend or This preferred structure pays a variable shorten the maturity, although this rate dividend, usually on a quarterly could not occur during any payment basis. The dividend rate tracks the deferral period. movement of a defined Treasury • Usually offer 5-year call protection security benchmark or LIBOR. when first issued. Adjustable rate preferred stock was • They pay quarterly and are generally designed to minimize price fluctuations cumulative. Most include a provision in response to changes in interest rates. which would allow the issuer to defer Adjustable rate preferreds are issued as payments for up to 10 years (only traditional preferred stock or as trust after payments are suspended on preferred securities. common stock and preferred stock). • Investors should review an issuer’s credit quality, giving more weight to the deferral option for lower- rated companies. If the issuer uses the deferral option, the investor is responsible for the taxes on interest earned but not received. Later, if the issuing company pays all of the