Capital Markets

Senate Targets Some Convertible Bonds

Under a current provision that might be eliminated, corporate issuers of certain hybrid securities can deduct the costs they would have incurred ha...
Stephen TaubJanuary 18, 2006

Some convertible bonds may soon be less appealing to issuers.

These hybrid securities, which that pay interest but also enable investors to convert them into stock, typically offer lower interest rates for this reason. Under current tax rules, corporate issuers can deduct the costs they would have incurred had they issued a higher-interest traditional bond.

The Wall Street Journal reported that the Senate version of the pending tax-relief bill, though not the House version, contains a provision that would eliminate this favorable tax treatment. No final version of the bill is ready for a vote, added the paper, which also noted the assertion of Lehman Brothers tax and accounting expert Robert Willens: “This is the kind of thing that usually gets enacted.”

The companies most affected, reported the Journal, will be those that sell convertible bonds with a contingent-payment feature, which pays different interest rates at different points in the life of the security, depending on whether the bonds trade above or below a certain price. Under the current Senate plan, issuers of convertible bonds would reportedly be required to deduct the comparable cost of borrowing as if they sold a straight convertible without the contingent-interest feature.

A little less than one-quarter of convertible bonds outstanding contain that feature, which first appeared in 2001, the paper noted. Indeed, the Journal observed that these contingent convertibles lost their popularity in 2004, when a similar provision was proposed as part of a different bill that didn’t make it through Congress.