Fixed Rate Capital Securities (FRCS)
Fixed rate capital securities (FRCS) (aka hybrids) are like preferred stock, but with a few peculiarities. There is no DRD tax advantage; thus, they pay a higher yield than preferred stocks or bonds from the same issuer. Their lien status is higher than preferreds but below creditors, and they carry the credit rating of the issuer. They are traded in the OTC market and most are also listed on the stock exchanges. Most are priced at $25 per share, have a stated maturity, and are callable after 5 to 10 years. Most issuers are utilities, industrial companies, and financial institutions.
FRCS are also classified based on how they are issued:
- Junior subordinated debentures are issued directly by the parent company.
- Trust preferred FRCS are issued by a trust.
- Partnership preferred FRCS are issued by a partnership.
Specific FRCS are known by acronyms and names which describe the frequency of the payments, or how they are issued, such as:
- MIDS - Monthly Income Debt Securities
- QUICS - Quarterly Income Capital Securities
- QUIDS - Quarterly Income Debt Securities
- QUIPS - Quarterly Income Preferred Securities
- SKIS - Subordinated Capital Income Securities
- TOPrS - Trust Originated Preferred Securities
- TruPS - Capital Trust Pass-through Securities
The main difference between preferreds and FRCS is that FRCS pay interest—not dividends—monthly, quarterly, or semi-annually, but can be deferred if the company is in financial trouble. However, payments can be deferred only if no dividends are being paid for the issuer's common or preferred stock, and if the interest payments are deferred, then interest continues to accumulate until it is paid. Sometimes FRCS are issued as zero coupon bonds, which are original issue discount (OID) instruments.
However, these securities can have tax complications, either because of interest payment deferral or because they are OIDs. In these cases, interest accrues, and if it is not paid in the year earned, then the investor in these securities must pay taxes on the accrued interest, which is calculated according to complex laws and formulas.
Besides the deferral risk mentioned above, there is also a special event risk, which allows the issuer to redeem the FRCS, at any time, for face value, if the tax law changes that disallows the tax deduction for the interest payments for the issuer's parent company.