What it means
A MIPS issuer, often a large company or bank, sets up a special-purpose subsidiary (a separate legal entity created for one financing purpose). The subsidiary sells the securities to investors and lends the proceeds to the parent in the form of subordinated debt (debt that is paid only after more senior creditors).
The appeal for the parent was tax treatment. Because the parent paid interest on the loan to its subsidiary, that interest could be deductible in many tax systems, while investors still received what looked like a preferred dividend each month.
For investors the attraction was a higher yield than ordinary bonds from the same issuer, paid monthly rather than twice a year. In return they accepted more risk, because the securities rank low in the pecking order and the issuer usually has the right to defer payments for a period.
Most MIPS also carry a call feature, meaning the issuer can redeem them early at face value after a set date. If interest rates fall, the issuer is likely to call them and replace them with cheaper funding, leaving the investor to reinvest at lower rates.
Be careful with the acronym, because MIPS is also used for unrelated things, such as a Medicare payment scheme in the United States and a measure of computer processing speed. In a finance glossary context it normally refers to the monthly income securities described here, and the label is now more often seen in older documents than in new issues.
When assessing an issue, investors compare the distribution rate with the yield on the issuer's ordinary bonds and ordinary preferred shares, and they look at the credit rating of the parent. A wide yield premium usually signals that the market sees extra risk in the deferral right or the low ranking.
In practice
Real-world examples.
Example
A bank holding company wants to raise capital without issuing ordinary shares. It sells MIPS through a subsidiary and uses the proceeds to strengthen its funding base while keeping existing shareholders' ownership intact.
Example
A retired teacher buys 800 securities with a $25 face value for $20,000 and receives a distribution every month. She likes the regular income, but she is aware that the issuer may defer payments in a downturn. She treats the holding as one part of a wider portfolio and does not rely on it alone.
Example
A regional power company calls its MIPS after market interest rates fall sharply. It repays holders $25 per security and issues new funding at a lower rate, reducing its annual financing cost. The saving goes straight into profit, while holders must find a new home for their cash.
Formula
Calculation
Monthly distribution = Total face value x Annual distribution rate / 12
A utility issues 12,000 securities with a face value of $25 each and an 8% annual distribution rate. Total face value is 12,000 x $25 = $300,000. Annual distributions are $300,000 x 0.08 = $24,000, so the monthly distribution is $24,000 / 12 = $2,000. An investor holding 600 securities, which is 600 / 12,000 = 5% of the issue, receives 5% x $2,000 = $100 per month.Case study
Seen in the real world.
Granite Peak Utilities is an illustrative, fictional power company that needed $50,000,000 for a new transmission line. Its board wanted funding that would not dilute shareholders and would not look like senior debt to its lenders.
The treasurer arranged a MIPS-style issue through a special-purpose subsidiary, with an 8% distribution paid monthly and a call date five years out. Investors bought the issue quickly because the yield sat above the company's ordinary bonds.
Three years later, in this fictional story, market rates dropped and the company redeemed the securities at face value. Investors received their money back but had to reinvest at lower yields, which is the classic call risk that income investors should price in.
Watch out
Common mistakes.
- Treating MIPS as ordinary bonds, when they rank below senior debt and the issuer may be able to defer distributions.
- Forgetting call risk, which means the high yield may only last until the issuer decides to redeem the securities.
- Assuming the monthly payment is guaranteed, when it depends on the issuer's financial health and the terms of the instrument.
Questions
People also ask.
Are MIPS debt or equity?
They are a hybrid, with debt-like fixed payments and preferred-share-like ranking, and the exact classification depends on accounting and tax rules.
Why monthly payments?
Monthly income appeals to retirees and income investors who want a regular cash flow that lines up with their monthly bills. It also made the securities easier to market against ordinary bonds that pay twice a year.
Are MIPS still issued today?
Their original form is now rare, but successor hybrid securities with similar features continue to be issued. Always check the terms of any hybrid before buying, because names and structures differ between issuers.
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