Small Banks Feeling TruPS Burden

NEW YORK (TheStreet) -- Trust preferred securities are becoming a big issue for little banks, although they don't appear to present as much of a problem for large, Bank of America(BAC)- and Citigroup(C)-scale financial services firms.

In pre-crisis days, trust preferreds -- or TruPS -- were often issued as a way to boost regulatory capital levels without diluting common stockholders. Interest payments could also be deducted for tax purposes. From an investor standpoint, TRUPs not only paid interest, but are "safer" instruments than common stock, because they're higher in the ownership structure and therefore a higher priority in case of liquidation.

TruPS grew so popular that issuance quintupled from $31 billion outstanding at 110 bank holding companies at the end of 1999 to nearly $150 billion at 1,400 firms at the end of 2008, according to the Philadelphia Fed.

But now, the TruPS market has gotten so discounted that in some cases banks are offering to outright repurchase the securities from investors for as little as 20 cents on the dollar. Unfortunately, this hurts not just the investors, but the banks themselves, which purchased pools of TruPS in the form of collateralized debt obligations, or CDOs.

Last week, Fitch Ratings became the latest agency to take further negative action on such CDOs. It downgraded 295 notes from 76 CDOs due to losses and defaults, and placed 179 notes on ratings watch negative. Most were already below investment-grade level.

Looking at fourth-quarter results at small banks across the country, the story appears grim.