Prof. Succo,

The piece you wrote on converts and mandatories was fantastic: an extremely cogent overview of a complex (at least to the under-initiated) topic.

I was curious about a point that you allude to but explicitly put to the side for purposes of focusing on your core points: the accounting and tax considerations that drive the issuance of mandatories. I'd have thought a mandatory looks more like equity for tax than a convert so therefore wouldn't create a deduction. And for accounting I'm not sure, but perhaps you don't record interest expense since this would feel more like equity? But what about EPS? If it were considered equity wouldn't you get treasury stock accounting?

Anyway, I realize that we don't know each other and you are presumably busy with real work. But since your column suggested that you possess a pedagogic instinct--or certainly aptitude--I thought I would ask you for further clarification.

Kind regards,
Minyan Jeff

MJ,

A mandatory is normally issued as a preferred stock with a par value as described in the article. For this type, from the company's standpoint, the coupon it pays is considered a dividend and is therefore not deductible for tax purposes. In addition, the preferred is considered equity and dilutive from the day it is issued.

But that wouldn't be what companies desire. Through legal opinions, the structure issued most these days, the ones used recently by Fannie Mae (FNM) and other financial companies, is called "mandatory units" and under this structure the dividends (coupon) is tax deductible and is considered debt on the day of issue, so the accounting treatment is non-dilutive. It is accounted for differently only at expiration or when the stock rises through the higher strike at which point it becomes dilutive.

- Prof. Succo
 

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