Fannie Mae-No Politics (FNMA)

[kthomp19]

I belueve that preferred stock is a credit to cash when initially sold and a debit to cash if redeemed or converted.

Redeemed, yes. Converted, I don't think so. A conversion event doesn't involve any cash coming in or going out so I don't see how cash would be affected at all.

Page 2 of this document from Wiley says what I believed was true: the conversion wipes out the (junior) pref line, adds the total par amount of the shares to common stock, and puts the rest (all of it in this cause because FnF's common stock has zero par value) into paid-in capital.

Halfway down this page we see something similar:

When convertible preferred stock is converted, the book value method is used. That is, the market value of the common stock is ignored because gain or loss cannot be recognized on a transaction involving only equity accounts. The journal entries focus only on the book value of the preferred and common stock.

Since the convertible preferred stock no longer exists after a conversion, the Preferred Stock account and the associated Additional Paid-in Capital on Preferred Stock account are debited (when equity accounts are reduced, they are debited). Since new common stock is issued upon conversion, the Common Stock account and the associated Additional Paid-in Capital on Common Stock are credited (when equity accounts are increased, they are credited).

Technically FnF pref shares are not convertible, but 2/3 of the holders of each series can vote to add an amendment saying that they will be converted (at an agreed-upon ratio) at a certain date or when a certain set of criteria is met.

The net result is no change in core capital because pref stock, common stock, and paid-in capital are all included. Also note that these examples show that cash is never changed in a conversion.