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I was looking at the list of US Bancorp preferred stock issues. Among them are:

  • Depositary Shares Each Representing a 1/1,000th Interest in a Share of Series B Non-Cumulative Perpetual Preferred Stock (NYSE: USB.H)
  • Depositary Shares Each Representing a 1/100th Interest in a Share of Series A Non-Cumulative Perpetual Preferred Stock (NYSE: USB.A)
  • Depositary Shares Each Representing a 1/1,000th Interest in a Share of Series F Non-Cumulative Perpetual Preferred Stock (NYSE: USB.M)

Notice how each issue uses depositary shares instead of the preferred shares directly. I am familiar with the use of depositary shares in the case of American Depositary Receipts (ADRs), but this use of depositary shares for preferred stock is novel to me.

Why would companies issue depositary shares for preferred stock instead of issuing preferred stock directly?

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From Quantum Online:

Depositary shares are issued so that a company may avoid a restriction in the number of preferred shares they may issue in accordance with their corporate documents. For example, a company might be restricted to issuing a total of 5 million shares of preferred stock. Let's assume that they have already issued 4 million shares and want to issue another 2 million shares at $25 per share. By the use of depositary shares they can bypass the restriction.

To do so they might issue 200,000 shares of preferred stock at $250 per share. Then, they sell to the public 2 million depositary shares with a liquidation value of $25 per depositary share, each representing 1/10 of a share of the $250 preferred stock. Using this magic, they have sold $50 million of preferred stock (more correctly $50 million of depositary shares representing preferred stock) and have only issued 200,000 shares of preferred stock against their 5 million share limit.

The ethics might be a little questionable but financially it works out well from the company's standpoint. From an investor's standpoint, it does not make much difference unless you are bothered by companies working around legitimate corporate restrictions.

Another gimmick that companies use is a Trust Preferred Security:

Trust preferred securities comprise most of the securities currently being issued by U.S. taxable corporations such as industrial and financial companies, utility companies, etc.

A trust preferred is a hybrid security comprised of a preferred stock and a debt security. To generate a trust preferred security, a taxable corporation sets up a trust which then sells preferred securities to the public. The trust then uses the proceeds from the sale of the preferred securities to buy debt securities from the company that have terms that are essentially identical to the terms of the preferred securities.

The purpose of this process is to make the company's payments on the securities tax deductible since they are paying interest on the debt securities sold to the trust. The companies also seem to be at least partially able to ignore the existence of the debt on their balance sheets since the trust actually sold preferred securities.

Trust securities have some troubling aspects for investors. First, the companies reserve the right to defer interest and dividend payments for up to five years on multiple occasions. Next, the company's guarantee is a bad joke. The company's essentially guarantees that they will guarantee that the trust makes the dividend payments on the preferred, but only if the company has made the interest payments on the debt securities.

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  • "For example, a company might be restricted to issuing a total of 5 million shares of preferred stock." What a silly kind of restriction! The restriction should be on the dollar amount rather than on the number of shares.
    – Flux
    Nov 4 '20 at 7:33

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