About Corporate Bonds
How Fixed-Rate Capital Securities Work
Domestic (U.S.) and multinational corporations issue fixed-rate capital securities to raise long-term capital at a fixed cost that is fully tax-deductible for the issuers. Typical issuers include electric and gas utilities, industrial companies, telephone companies, insurance companies, banks and other financial institutions. Over $160 billion in fixed-rate capital securities have been issued since 1993.
Advantages to Issuers
Unlike common and preferred stock dividends, the distributions made on fixed-rate capital securities are fully tax-deductible for the issuer,1 just like the interest payments on traditional debt issues. Rating agencies have taken a positive view of this financing tool for the issuer, because it provides long-term capital and permits the deferral of payments should the issuer experience financial difficulties. However, as with preferred stock, such deferrals can only occur if the parent company stops all other stock dividend payments.
Three Basic Structures
The current market includes three basic types of fixed-rate capital securities, which differ primarily as a result of whether the parent company issues the securities directly or through a conduit financing vehicle. With preferred partnership securities, the conduit issuer is either a limited partnership (LP) or a limited liability company (LLC) organized by the parent company. With trust preferred securities or capital securities, the conduit issuer is a grantor trust established by the parent company. In these two structures, the partnership or trust uses the amount raised by the offering to purchase junior subordinated debentures2 of the parent company. The proceeds from the transaction may then be used by the parent company for general corporate purposes. The fixed-rate capital securities may also be issued directly as junior subordinated debentures of the parent company. Throughout this brochure, these structures are referred to as partnership, trust and debt securities, respectively.
Depending on the investment bank that serves as the issuer’s underwriter, the securities may also be identified by service- or trademarked acronyms such as: MIDSSMSM (Monthly Income Debt Securities), MIPSSMSM (Monthly Income Preferred Shares), QUICSSMSM (Quarterly Income Capital Securities), QUIDSSMSM (Quarterly Income Debt Securities), QUIPSSMSM (Quarterly Income Preferred Securities), SKISSMSM (Subordinated Capital Income Securities), TOPrS™ (Trust Originated Preferred Securities), TruPSSMSM (Capital Trust Pass-through Securities), Trust Preferred Securities and Capital Securities.
This chart compares the features of these structures:
1 Distributions on fixed-rate capital securities are fully taxable for the investor. See taxability of income for more information.
2 The promise to pay on junior subordinated debentures cannot legally be fulfilled until payments on certain other types of “senior” obligations have been made and any other conditions, as defined in the indenture (the legal contract between issuer and trustee for the benefit of investors), are met. Holders of junior subordinated debentures still rank ahead of preferred and common shareholders, though, in terms of the issuer’s payment responsibilities.
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.