Debenture Explained (and why they are in news)

Definition of ‘Debenture’

A type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are documented in an indenture.

In Other Words ,

A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral.

In corporate finance, the term is used for a medium- to long-term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note.

A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure, it does not become share capital.Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.

Bond buyers generally purchase debentures based on the belief that the bond issuer is unlikely to default on the repayment.

An example of a government debenture would be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at worst, can print off more money or raise taxes to pay these type of debts.

Most debentures pay a fixed rate of interest. It is required that this interest is paid prior to dividends being paid to shareholders. Furthermore, most debentures are secured on the borrower’s assets, although some are not (these can be known as naked or unsecured debentures – most debentures in the USA are unsecured).

Debentures are generally freely transferable by the debenture holder.

Attributes

• A movable property.
• Issued by the company in the form of a certificate of indebtedness.
• It generally specifies the date of redemption, repayment of principal and interest on specified dates.
• May or may not create a charge on the assets of the company.
• Corporations often issue bonds of around USD 3 billion(within the total limit of USD 25 billion), while government bonds are more likely to be USD 25 billion.

Debentures gave rise to the idea of the rich “clipping their coupons,” which means that a bondholder will present their “coupon” to the bank and receive a payment each quarter (or in whatever period is specified in the agreement).

There are also other features that minimize risk, such as a “sinking fund,” which means that the debtor must pay some of the value of the bond after a specified period of time. This decreases risk for the creditors, as a hedge against inflation, bankruptcy, or other risk factors. A sinking fund makes the bond less risky, and therefore gives it a smaller “coupon” (or interest payment). There are also options for “convertibility,” which means a creditor may turn their bonds into equity in the company if it does well. Companies also reserve the right to call their bonds, which mean they can call it sooner than the maturity date. Often there is a clause in the contract that allows this; for example, if a bond issuer wishes to rebuy a 30 year bond at the 25th year, they must pay a premium. If a bond is called, it means that less interest is paid out.

Failure to pay a bond effectively means bankruptcy. Bondholders who have not received their interest can throw an offending company into bankruptcy, or seize its assets if that is stipulated in the contract.

Debenture holders

Debenture holders (investors) do not have any rights to vote in the company’s general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures.

The interest paid to debenture holders is calculated as a charge against profit in the company’s financial statements.
Advantages  

The main advantage of debentures to companies is the fact that they have a lower interest rate than e.g. overdrafts. Also, they are usually repayable at a date far off in the future.

For an investor, their main advantages are that they are often easy to sell in stock exchanges and they contain less risk than e.g. equities.

Security

In Asia, Securities are of following three types as mentioned :

• if repayment is secured by a charge over land, the loan document is called a mortgage;
• where repayment is secured by a charge against other assets of the company, the document is called a debenture;
• and where no security is involved, the document is called a note or ‘unsecured deposit note’.

Convertibility

There are two types of debentures:

• Convertible debentures : These are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time.“Convertibility” is a feature that corporations may add to the bonds they issue to make them more attractive to buyers. In other words, it is a special feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert, convertible bonds typically have lower interest rates than non-convertible corporate bonds.
• Non-convertible debentures :These are simply regular debentures, cannot be converted into equity shares of the liable company. They are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts.

Contemporary ,It is in news because 

K. M. Abraham

Subrata Roy

• Sahara India Real Estate Corporation (SIREC) and Sahara Housing and Investment Corporation (SHIC) — may actually have been laundering money in the names of fictitious investors.
• Sahara questioned SEBI’s power to regulate optionally fully convertible debentures (OFCDs), and also contended that the funds were raised through private placements and, therefore, not under the market regulator’s purview.
• The definition of ‘securities’ under the Securities Contracts (Regulation) Act is an inclusive one and not exhaustive and that OFCDs would come under its purview.
• An offer made to 50 or more persons ceases to be a private placement under the Companies Act. SIREC alone had about 6.6 million investors in its OFCD scheme. Complete details of these investors were not available with SIREC, and Dr. Abraham’s(former board member of the Securities and Exchange Board of India (SEBI) and the man who investigated the Sahara scam) random test of four addresses of ‘investors’ in Mumbai revealed that only two existed and even these two had nothing to do with the Sahara group. This revelation was important to demolish Sahara’s argument that this was a private placement meant for people associated