Monday, November 12, 2012

Convertible & Non-Convertible Debentures !

Convertible Debentures:
Convertible debentures are debt instruments where the debt holders earn a fixed rate of interest and gives the holders the flexibility to convert the debentures into common stock(equity shares) whenever they want (upto the maturity of the debenture). They are not listed on stock exchanges, thats what Sahara Group(Read here) also did.

Non-Convertible Debentures:
Non convertible debentures (NCD’s) are those debentures which are not convertible to equity shares and hence offers higher rate of return than convertible ones.
They are listed on stock exchanges. Hence, provides liquidity to holder. The tenure of NCDs can be anywhere between 2 years and 20 years. NCDs are rated by rating agencies such as CRISIL.
Case Study
IFCI (into Industrial Financing) was helped by Govt. of India in 2001 and 2002 by a total sum of Rs 923cr in a way of Convertible Debentures. IFCI was helped that time to pull it out of bankruptcy and default on payment. One point to be noted here is that according to capital adequacy norms, Tier-I capital cannot be in form of convertible debentures. IFCI and Govt. of India then had made a case with RBI that it be considered so and it was later approved by RBI.
(Note: Tier-1 capital of a financial institution CANNOT  be in form of Convertible Debentures)

Now, in the month of Aug 2012, Cabinet took a decision that since  IFCI is now making profits therefore Govt. of India must convert its Convertible Debentures  into equity shares @ par (which means at face value of share, which is Rs 10). This decision was later approved by SEBI.  This move made Govt. of India, now a shareholder of IFCI(since they now have equity shares) and a shareholding of around 55% and if we consider the PSUs Banks/LIC/other PSUs(because they may have bought IFCI shares in past, to provide IFCI with some capital), Govt. of India’s holding goes upto 68%.

Since the convertible debentures were converted into equity shares at face value(@par), the EPS(Earnings per Share) of shares were affected (dropped) and hence hurting existing shareholders. If the conversion would have happened at market price, things should have been fine.

Note: Recent Financial Restructuring Plan (FRP) and Turn Around Plan (TAP) of Air India (euphemism for bailout package :) ) consisted of NON-CONVERTIBLE DEBENTURES. So it cannot be converted into equity shares later on. Why NCD? Because govt. already has 100% holdings in Air India Ltd. !!!  

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