Terms Beginning With 'd'

Debenture

  • January 09, 2020
  • Team Kalkine

What are Debentures?

A debenture is an instrument through which an organisation raises loan from the market by issuing some certificates with the organisation’s seal and is known as Debenture Deed. Debentures are issued, just like equity shares, either through a private placement or offering to the public. Large companies generally raise fund through debentures without diluting the equity of the company.

When a company raises fund through debentures, the risk perception of equity shareholders increases as the debenture holders will be entitled to some fixed interest. To maintain a balance between the equity and debenture holders, the company has to increase the dividend payout ratio to the equity shareholders.

A company may issue debentures with an option to convert them into equity shares, either wholly or partly at the time of redemption only after the approval by a special resolution passed at a general meeting. The debentures with an option to convert into equity do not carry any voting rights.

Based on the nature of issuance and redemption of debenture, it can be issued with five possibilities.

  1. Debentures issued at parity and redeemable at parity.
  2. Debentures issued at a premium and redeemable at parity.
  3. Debentures issued at a discount and redeemable at parity.
  4. Debentures issued at parity and redeemed at a premium.
  5. Debentures issued at a discount and redeemed at a premium.

Debentures are issued with a fixed rate of interest, and the interest amount is paid either yearly or half-yearly basis. The interest payable is a charge against the profits of the company, and like other debts, has to be paid in case of losses too.

What are the different types of debentures?

  1. Redeemable and Irredeemable Debentures

As the name suggests, Redeemable debentures are issued for a specified period, after which the company must repay the amount on a specified date.

Irredeemable debentures are those who have no specified fixed date for repayments. The debenture holders cannot ask for the payment as long as the company is operational and does not default on interest payment. They are perpetual in nature and are paid back usually when the company goes into liquidation. Companies normally issue redeemable debentures.

  1. Registered and Bearer Debentures

Registered debentures are registered in the name of the holder. Registered debentures are transferable in the same fashion as shares are transferred through transfer deeds. Interest is paid to the person whose name is registered in the register of debenture holders.

Bearer debentures are unregistered and unsecured bonds. The company does not maintain any record for the holders. Usually, a coupon is attached to the debenture certificate for the purpose of interest payment.

  1. Secured and Unsecured Debentures

Secured debentures are also known as Mortgaged debentures. They are secured either by a mortgage of a particular asset of the company known as Fixed Charge or by the mortgage of general assets known as Floating Charge.

Whereas, Unsecured debentures are not secured by any charge or mortgage on any property of the company. Also known as 'Naked Debentures', companies with a good track record and strong financial standing can issue such debentures.

  1. Convertible and Non-convertible Debentures

Convertible debentures provide an opportunity to the debenture holders with an option to exchange a part or whole of the debenture amount into equity shares of the company on the expiry of the debenture period.

When only a part of the debenture amount is convertible into equity shares, it is known as 'Partly Convertible Debentures'.  The debentures whose full amount is convertible into equity shares are known as 'Fully Convertible Debentures'.

As the name suggests, Non-convertible debentures, are those where holders do not have any option to convert them into equity shares.

Image source - © Kalkine Group 2020

Investors try to maximise their return as high as possible. There are investors who have a higher risk appetite and invest in a high-risk portfolio. Debentures do not provide comparatively high returns on investments but provide a fixed and minimum risk-return.

Investors with a low-risk appetite as that of a younger person should think of debenture as an investment tool having fixed income and minimum risks.

What is Leverage Ratio? Leverage Ratio is a quantitative measure indicative of the proportion of the business capital represented by debt. In other words, it highlights the extent to which a firm uses debts rather than equity for financing its operations. The leverage ratio is used for gauging the risk surrounding investment and evaluating if the company is able uphold its financial commitment.  The leverage ratio also pinpoints the degree of backing provided by the equity capital to the debts of the company. Significantly, the leverage ratio varies with respect to the industry and company types. For example, in the airline industry, banking institutions, capital goods businesses, have substantially higher leverage ratio. Furthermore, the startups also have a high leverage ratio  Good read: Understanding Types Of Leverage Ratios What is the Concept of Leverage? The term ‘leverage’ is generally used in relation to the investment strategy that uses loans or debt for financing its assets and overall increasing the return potential. At the same time, this strategy also increases the downside risk and makes the investment risky. This type of leverage represents financial leverage.  The total leverage can be broken down into Operating Leverage and Financial Leverage. In simpler terms, the cost structure of the operations is responsible for operating leverage, while the capital structure of the company accounts for financial leverage.  Notably, a high fixed cost leads to high operating leverage, and the high debt-level in the company’s capital structure denotes high financial leverage.  Kalkine Image The use of leverage within the business can maximise both gains and losses.  Why is Leverage Ratio Important? Businesses at a certain point borrow funds by issuing bonds or taking loans from banks, in cases when They do not possess substantial funds that are needed for pursuing operations or expansions They want to leverage borrowings for increasing return potential The objective of borrowing loan and debt is to maximise the wealth via investment. However, in case of investment failure, the business faces twofold challenges which include loss of the original investment and additional interests burden that must be paid to the lender. Thus, the objective of wealth maximisation is only attained if the return on investment is higher than the interest or cost of the debt capital. Good read: What Is Return On Invested Capital (ROIC)?  Concurrently, in case of investment failure, the lenders are also exposed to default risk, with the borrower unable to pay the principal or interest on the loan amount. In order to evade default scenario, the creditors evaluate the financial aptitude of the company using the leverage ratio.  Watch: What are Interest Rates? Also watch: What are the Key Determinants of Interest Rates? Leverage ratio indicating a significantly very high proportion of debt can be a dangerous sign for both the investors as well as the company as it indicates chances of credit downgrades and bankruptcy. However, a very low leverage ratio may point towards a conservative approach taken by the management, typically, at the cost of growth. The leverage ratio sheds light on how the variability in the output could impact the company’s income.  Leverage ratio is utilised not only by the management and the creditors, but the credit rating agency also use it for assessing the company’s overall health, its ability to fulfil obligations and analyse its future potential in terms of running a business and expanding.  Must read: Role of rating agencies and their impact on your investments What are the Types of Leverage Ratio? Common Leverage Ratios Debt-to-Equity Ratio The ratio gives the measure of the total business’ obligations with respect to the shareholder’s equity. The ratio indicates the extent of dependency of the company on the debt capital for pursuing its undertakings. Creditors and investors use the ratio for analysing the credit worthiness of the loan or debt.  High D/E ratio highlights that owners with limited capital investment can retain a significantly higher degree of control on the business. However, it potentially limits further borrowing opportunities.  Total Debts represent debentures and long-term loans. Total Equity is the combination of shareholder’ Equity, Reserves and surplus and Retained Profits.  Debt-to-Capital Ratio The ratio indicates the degree of financial leveraging used in financing the business operations by comparing its total obligations against the total capital.  The ratio is calculated by dividing the Debt of the Company by the total capital, which represents the sum of the shareholder’s equity and total debt.  High debt-to-capital ratio signifies the risky nature of the business. Nevertheless, it should be noted that the value of the ratio varies with respect to the industry and also if the company is new or old.  Debt-To-EBITDA Leverage Ratio The ratio compares the financial borrowings of the company against the Earnings before Interest, Taxes, Depreciation and Amortisation (EBITDA). The ratio indicates the company’s ability to pay its debts by utilising the income generated from its operations.  Total debt in the formula represents both long term and short-term debts.  EBITDA= Net Income+ Interest Expenses+ Tax Paid+ Depreciation/Amortisation Debt to Assets Ratio Debt to Assets Ratio indicates the proportion of the total assets that are financed by the liabilities of the company. Thus, it highlights the contribution of creditors in funding the assets of the company.  The total debt in the above formula does not include shareholder’s capital. The ratio above 0.5 indicates that the company’s major proportion of the asset is financed using the borrowings rather than from the investor’s fund.   Coverage Ratios  Interest Coverage Ratio The interest coverage ratio indicates how well a company can pay the interest on its outstanding debt using the company’s operating profit, (EBIT).  The high-interest coverage ratio indicates company is well positioned to meet its interest obligations via the business operations. Significantly, lenders, investors and creditors evaluate the interest coverage ratio for ensuring if they will be paid their dues in a timely manner. Debt service coverage ratio This ratio ascertains if the company will be able to pay its current debt obligations or debt service by means of its operating profit. Significantly, debt service includes the repayment of principal as well as interest on different debt types for a particular period. Typically, DSCR of less than 1 signifies that the borrower will not be able to meet its current debt obligations from its business operations entirely.  Fixed-Charge Coverage Ratio The fixed charge coverage ratio is the ability of the firm to cover fixed-charge obligations such as debt payment, and expense of leases and interest.  The ratio gives a broader measure of the company’s ability to meet the current due, including fixed charges on leases, principal repayment along with the interest return.  Asset Coverage Ratio The asset coverage ratio indicates how well the firm will be able to meet its borrowing obligations by selling the assets.  The higher value of the ratio indicates that the company has more assets than the liabilities. The banks and creditors use the ratio to analyse the risk associated with lending the capital. 

Capitalization is a narrow term that represents permanent investment in companies such as debentures, loans, free reserves, share capital excluding long-term loans. Capitalization can be distinguished from capital structure.

Long-term liabilities, also known as noncurrent liabilities, are a financial obligation that result from an earlier incident that is not due within next 12 months. Long-term liabilities are listed in the balance sheet of the company after more current liabilities, in a segment that might comprise deferred tax liabilities, pension obligations, loans and debentures.

Define Australian Real Estate Investment Trusts (or AREITs) & its fundamentals AREITs (Australian real estate investment trusts) give an individual opportunity to invest in property assets of Australia. An individual can invest in assets that would have been otherwise out of reach like large-scale commercial properties, which is a major advantage of AREITs. The Australian property market is expensive and competitive but through AREITs the investors are able to get a slice of the property pie without making huge down payment. Therefore, the investors looking to diversify their portfolio into property may invest through A-REITs and may receive a regular and consistent income stream in the form of distributions or dividends. Read: How Should An Investor Diversify A Portfolio? A-REITs can build wealth of an individual in two ways. First, the investor will get the exposure to the real estate assets that the trust owns and will also receive capital growth and the rental income, a source of passive income. The fund managers of AREITs make the selection of the investment properties and will oversee all its administration, improvements required, maintenance of the properties and rental. Each A-REITs have their own set of characteristics & features. The fund manager selects the properties that are diversified across regions, how much are the lease tenure and tenant types. Some A-REITs specialise in specific sectors, like an Industrial trusts makes their investments in warehouses, factories, and industrial parks, Office trusts undertake investments in medium- to large- scale office buildings in and around major cities, hotel and leisure trusts invest in hotels, cinemas and theme parks, Retail trusts invest in shopping centres and similar assets, and diversified trusts generally invests in a combinations of industrial, offices, hotels and retail property. AREITs may have assets in commercial buildings, apartments, resorts, facilities and even mortgages or loans. A News from an Office REIT: Centuria Office REIT Secures Additional Seven-Year Debt Facility AREITs gets their income mainly from rent, where rents are quoted on a dollar per square metre basis. There’s difference between rents from residents & commercial leases. Residential rents are well regulated but in case of commercial leases there are differing types of rentals or leases. AREITs purchase buildings as going concerns and where there are already tenants, while some AREITs also develop the properties. Read: Centuria Metropolitan to Acquire Office Assets; Announces Dividend Further, AREITs in their portfolio can hold either domestic or international property assets. Outside of Australia, the main countries in which AREITs hold assets and the investors can have the exposure are the United States, New Zealand, and the United Kingdom. Net tangible assets (NTA) reflects the underlying properties in an AREITs and is considered as an important measure of the true value of an AREITs. How many REITs are there in Australia? As  there are 38 REITs listed on the ASX All Ordinaries Index in which the investors can invest. They have a total market cap of over $100 billion. Meanwhile, AREITs are generally gets listed on the Australian Securities Exchange (ASX) in the form of listed investment company (LIC). These listed AREITs on the ASX have to abide with the rules & regulations set out by the ASX. Whether real estate investment trusts are good investment? What are the benefits? It’s been analyzed that AREITs have posted good returns on the back of high, steady dividend income and long-term capital appreciation. The investors looking for diversifying their portfolio consider this as they have relatively low correlation when compared to other risky assets. Read: Inevitable Gains: ASX 200 Property listing stocks and Bounce in Property Space Therefore, AREITs help in reducing overall portfolio risk and enhancing the returns. Further, investing in AREITs is considered to be safe and proven form of creating wealth. An individual can achieve a good return on investment with approximately 30% of all Australian residents rent their residents, therefore the continuous demand for rental will remain across the country. Let’s list out the benefits or advantages of investing in AREITs. 1) Stability of getting decent returns: The AREITs have posted the good growth. The country has posted more than 16 consecutive years of positive economic growth, which means the averaging 3.7 percent pa. This also reflects that the Australian economy is quite resilient, able to combat situations even there are wars, disasters, recessions, bush fires and other such crises. This makes Australian real estate investment a safe one. In addition, great number of individuals employed is in Australia, which makes it easier to rent. There are lots of other advantages for owning rental properties in Australia as an individual may have access to tenants that pay their rent on time, which, in turn, helps the individual’s wallet. Writeup on property stocks: 6 Property Space Stocks to Look At - LLC, DHG, REA, BKW, JHX, BLD 2) Easy Availability of Financing: In Australia, an individual can obtain financing easily, as the banks or financial institutions readily lend money for residential properties than any other forms of investment class. These banks or financial institutions may lend up at as high as 95 percent of the requirements. Further, overall interest rates are also low. Good Read: Breaking Down Monetary Policy Instrument- Interest Rate On the other hand, the general financing pattern for AREITs is to finance real estate acquisitions through unsecured credit and then refinance the debt with common or preferred stock offerings or senior notes and subordinated debentures because they lack the ability to retain much cash (95% of income must be distributed to shareholders). Read: Centuria Industrial REIT Announces Equity Raising 3) Favorable Australian Tax System to Real Estate Investors: The Australian tax laws are friendly to an individual who wants to invest in real estate. Like, the law permits an individual to write off investment expenses against taxes, which will lower the tax bill and offsets shortfall between the rental income and holding costs, either in part or in full. This makes the act of investing in real estate more attractive for Australians who are not necessarily affluent. Tax reforms: Additional Tax Reforms Would Revive Growth – Economists   4) Superannuation Funds:  In Australia, the investors have the option of investing into superannuation funds (which are retirement funds), called super funds for short. Although this money has been around for a long time, and the recent changes in Australian borrowing laws has made this option more feasible for property owners. Meanwhile, there is a capital gains tax on a sale of property. However, if an individual at or above age of 60 years, the tax is zero. According to the new rules, the investors are also allowed to renovate properties that are held in the fund. More on Super funds: Confused About Superannuation or Super Funds? This Guide Will Help You 5) Government Incentives: Other advantage of investing in AREITs is that the government offers rewards for such investment by giving grants. For example, the First Home Owners Grant. However, the grant monies are different among the states, but it can be in range anywhere from $7,000 in Tasmania to 15,000 in New South Wales and other places as well. Good Read: Is it a Big Smile for Home Builders with $25,000 Grants: Unboxing the Government’s Offering 6)Liquidity: The AREITs are traded on the stock market, an investor can buy or sell them during trading hours. This makes AREITs a highly liquid asset, primarily when compared to traditional real estate investing. AREITs make a diversified investment option as they offer exposure to different parts of the property market. Further, the investor gets access to lots of Australia’s highest quality properties across the retail, office, industrial and residential sectors and more etc. held through property stocks listed on the ASX. More on property stocks: Top Australian Property Stocks Listed On ASX Meanwhile, some AREITs adopt hybrid structures called ‘stapled securities’ funds. These stapled securities AREITs offer an individual to have an exposure to a funds management or a property development company, as well as a real estate portfolio. A share in a stapled securities fund comprises of one trust unit and one share in the funds management company. These securities are ‘stapled’ and therefore cannot be traded in a separate way. The AREITs holds the portfolio of assets, while the related company carries out the fund’s management functions or manages any development requirements. On the other hand, the investment in stapled securities may have tax implications for an individual.

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