The diversified trust preferred CDO (DTP CDO), one of the newest CDO products, first appeared in the CDO market in 2000. The collateral, trust preferred securities, has been a favored capital option for larger financial institutions. Since 1996 when the Federal Reserve Board (FRB) approved trust preferred securities as Tier 1 capital, public trust preferred issuance reached $55 billion in total as of June 2002.
While larger banks have benefited from using trust preferreds as a cheaper capital source, smaller regional banks had not, prior to the advent of DTP CDOs. Historically, trust preferred usage differed dramatically across banks. Excluding the trust preferreds issued through DTP CDOs, we estimate that only 2% of smaller banks issued trust preferreds vs. 32% for larger banks (e.g., with more than $5 billion in assets) vs. 60% for the largest banks (e.g., top 50 banks by asset size). The primary reasons smaller institutions have not issued trust preferreds are high transaction costs for issuers and investor perceptions of greater event risk and less liquidity associated with individual small banks. These factors impede small banks' ability to access the capital markets on a stand-alone basis.