What are P Caps?
What are some examples of P-Caps?
What are the essential elements you should know!
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What does a P Cap mean and what should you know!!
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What Are P Caps
P Caps refers to “pre-capitalized” securities.
For instance, a newly formed trust can issue P Caps (or pre-capitalized trust securities) to obtain the necessary funds necessary to invest in a particular way.
By way of example, we can refer to the Lincoln National Corp (LNC) that created a new trust called the Belrose Funding Trust and issued $500 million of P-Caps where the proceeds were to be used to invest in a portfolio of principal and interest strips of US Treasuries.
Then, the trust would enter into a facility agreement with the LNC allowing it to deliver senior debt to the trust in exchange for the US Treasures (also referred to as the eligible assets).
As you can see in this transaction, LNC creates a trust that issues $500 million of P-Caps to buy US Treasuries (the eligible assets).
Then, LNC enters into a contract with the trust giving it the right to deliver senior debt to the trust and get in exchange the US Treasuries.
According to Investopedia, capitalize is defined as:
To capitalize is to record a cost or expense on the balance sheet for the purposes of delaying full recognition of the expense. In general, capitalizing expenses is beneficial as companies acquiring new assets with long-term lifespans can amortize or depreciate the costs. This process is known as capitalization.
In other words, to capitalize or capitalization means to “record” an asset on the company’s balance sheet.
Since the cost associated with a capital investment is to fund an asset, the expenditure will appear on the balance sheet and not the income statement.
P Cap Example
Let’s look at an example of how P Caps can be issued in practice.
In 2019, a Delaware statutory trust (called Harborwalk Funding Trust or HFT) was formed by the Massachusetts Mutual Life Insurance Company (MassMutual) intended to serve as a source of liquidity for it.
In essence, between $500 million to $1 billion of pre-capitalized trust securities (referred to as “P-Caps”) were expected to be issued.
According to the terms of the transaction, the trust is intended to issue P-Caps and use the proceeds of the issuance to purchase US Treasury securities.
Then, MassMutual will have the right to demand that the trust purchase its Fixed-to-Floating Surplus Notes in exchange for parts or all of the US Treasury securities.
In this context, Moody’s rating of the MassMutual P-Caps corresponded to their A1(hyb) surplus notes as the P-Caps were considered to have similar characteristics.
P Caps Provision
Whenever companies transact P Caps, it’s possible that they enter into various types of agreements to define how the P Caps are to be handled.
As such, it’s important that the contract accurately define the P Caps to ensure that the contracting parties are making reference to the right securities.
An example of how P Caps can be defined in a contract is as follows:
P Caps are hereby defined as the pre-capitalized trust securities issued by the trust with respect to the assets held by the trust
In essence, a P Cap can be defined by the parties based on their specific needs and contractual purpose.
P Cap Takeaways
So there you have it folks!
What are the P Caps?
You may assume that “P Cap” is a hat with a “P” on it….but that’s not what it means in finance!
In finance, a P-Caps refer to securities issued on a “pre-capitalized” basis.
In other words, the securities are to be issued by a legal entity (like a trust company or statutory trust) and then capitalized.
For example, major corporations, insurance companies, or other entities may:
- Form a new trust
- Have the trust issue P Caps
- Use the P Cap proceeds to create an investment portfolio
- The corporation will then enter into a contract with the trust
- The contract will require that the trust purchase notes or debt from the corporation
- In exchange, the corporation will receive part or all of the trust’s investment portfolio
As you can see, with this type of setup, a corporation is able to shelter significant sums of money in a trust and should it need liquidity, it can exercise its right to impose on the trust to buy debt or notes from it.
I hope this article helped you better understand the meaning of a P Caps.
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P Caps Meaning
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