My kingdom for a debenture
Corporate debentures are one means for companies to raise cash on the cheap. No wonder they are increasingly popular
Tata Capital Limited (TCL) was born on September 1, 2007, with the intent to bring the trust and expertise of the Tata Group to the vibrant financial services sector. When Tata Capital commenced operations, the idea was that this new company – one of Tata’s constellation of 98 companies in all – would provide diversified financial offerings to retail, corporate and institutional customers. Thus commences the journey of TCL as a wholly-owned subsidiary of Tata Sons Limited, registered with the Reserve Bank of India (RBI) as a ‘Systemically Important Non Deposit Taking Non Banking Financial Company’ (NBFC for short; see box).
Opting for debentures
The TCL senior manager explains that for the financing needs, there were several reasons to choose a debenture. In their board meetings, it was decided to test the bond/debenture market since it was a rather dormant segment that could also be developed for future uses. It also offered many advantages both for the investors as well as for TCL.
Moreover no private sector company in India had introduced non-convertible debentures (NCDs) in the retail market in the last few years. TCL was confident that this instrument would be well-accepted by investors, and could lead to the development of a strong corporate bond market.
Professor Alok Pandey of the IMT-Ghaziabad business school provides some perspective: “Another factor for Tata Capital was certainly that interest rates for a bank loan would have been somewhat higher than what they would pay via the debenture. On a Rs 1,500 crore issue, a 1%-difference in interest paid means Rs 15 crore saved per year – not exactly small change, even for a giant like Tata. More specifically, they are paying about 11% to 12% to borrow money from the debenture holders, whilst they will be making loans to third-parties at higher rates – maybe even as high as 15% or 16% for personal loan, for example for automobiles.”
Professor Pandey continues by explaining the financing options open to most companies: “There are fundamentally three financing tools that companies can select from: bank debt, raising additional new capital by issuing shares, or corporate debentures (also known as corporate bonds).”
Debentures presented several important advantages:
- They are quite quick to put into place, especially compared to issuing shares
- The costs are competitive
- Favourable interest rates with respect to bank debt
- Non-convertible option, implying no dilution of company capital
Who does what?
Although issuing debentures is simpler than increasing share capital, it is nonetheless an operation that requires at least two to three months of preparation, and many man-hours of work, in order to ensure a smooth sales, and hopefully an oversubscribed debenture issue. (See chart 2)
In the case of the Tata Capital debenture, the planning phase was done in close association with Tata Capital Markets, the group’s investment banking arm, which provided critical advice on the parameters of the debenture: size of offering, interest rate to be offered, options, term, convertibility, and so forth. Additionally, given its exposure to the pulse of the market TCM could provide a qualitative assessment of market conditions. See box 1 –First Steps.
For other companies not having in-house financial experts and brokerage services, this first step might have been done with a financial consultant, or even with the issuer’s main bank. One of the first roles of such a consultant would have been to help choose the financing option. Some non-financial companies might have used a consultant at this stage, in order to choose the proper financial instrument (e.g. some companies might have chosen bank debt whilst others might have opted for a capital increase).
Structuring the debenture
After assessing the market conditions, TCL management settled on a non-convertible debenture (NCD). The reasoning here is straightforward, explains professor Pandey: “By offering NCDs – i.e. debentures that cannot be converted into company shares – TCL is avoiding the need to take on new shareholders, which would also have an impact on its long-term financials, namely earnings per share (EPS). Why? These debenture holders appear as debt on the Tata Capital balance sheet and not as equity.”
Next, since the rating for the NCD was very good, the amount to be raised could be quite substantial. Although TCL’s target was to raise at least Rs 500 crore, they also wanted to capture larger resources if the issue went well, so an option was kept open to increase the take to Rs 1,500 crore. Professor Pandey justifies their tactical reasoning: “Since the debenture issue and sale is a big effort and does carry some risk of failure, it makes full sense for the issuer to keep the size open-ended on the upside. The issuer can amortise some fixed costs – such as legal fees or promotional expenses – on a greater issue size.”
In the end, Tata offered four debenture options (see table). It was decided that the debentures would have a term of five years, meaning that the principal could first be redeemed in 2014 at the latest. A put and call option at the end of 36 months and 42 months was also built into the offering. Bondholders have the option to surrender the debenture before its maturity (after the pre-specified period). Conversely, the company can ask bondholders to surrender the debenture before its maturity (after the pre-specified period). This provides flexibility to both company and investor.
Lead manager
With the basic parameters of the debenture settled, the action could begin, namely the sale of the paper. This is when another very important player comes into the picture: the lead manager, sometimes called the underwriter.
This is the company that advises the issuer on the prospectus, on the risks, on the terms that should be offered, and on legal aspects. The lead managers for the Tata Capital debenture were ICICI Securities, Citigroup Global Markets and DSP Merrill Lynch. This trio of lead managers coordinates with the various brokers to make sure that the sale is going smoothly. Overall the TCL non-convertible debentures were subscribed to by ca. 140,000 investors, representing a mix of individual, corporate, institutional and even government investors.
Another important actor in the chain are the so-called ‘bankers to the issue’, where the monies from investors are collected. The Tata debenture called upon three banks: ICICI, HDFC and ING Vysya. These financial institutions are primarily responsible for matching funds received from the particular investors.
Selling the paper
Because the TCL debenture only had a three-week sales window (from February 2 to 24), it was crucial to plan the sale appropriately. The debenture’s promotion included two channels: promotion to the financial specialists, via well-trodden methods; and promotion to the general public, via a mass media campaign in various large-scale media such as newspapers and magazines.
The first sales channel includes the bread-and-butter of purchasers of financial instruments: brokerage houses, banks, institutional investors and other finance-dedicated organisations. TCL appointed nine ‘lead brokerages’ to help coordinate the sale, and ensure good penetration down to small-scale financial players. Yet there was no exclusivity or privileged deal for these nine lead brokers or any other broker whatsoever.
The second channel was more unusual: retail investors. To reach this target, TCL developed a full-scale advertising campaign. Tata Capital also tapped into its subsidiary Tata Securities and one of its business divisions – Wealth Management – to propose the investment to internal customers.
Oversubscribed – now what?
The selling went so well that in the end, the Tata Capital debenture raised Rs 3,000 crore during its 3-week sale period, or six times the minimum issue size. Twill be retaining Rs 1,500 crore from this issue, with the remaining Rs 1,500 crore being returned to investors after allotting the debentures to the lucky investors.
The allotment gives priority to retail investors and then to brokerage houses and others. It is expected that institutional investors will not be allotted their requests and will get refunds.
The check please
Raising money incurs costs, whether the new financing comes from shares, from bonds, or from debt. There are three main cost components for the issuer. Firstly, fees that have to be paid as commissions (to underwriters, brokerage houses or other sales intermediaries). A high-rated issuer can expect to pay the brokerage houses a commission of at least 0.3% (although 1% to 1.5% is more then norm), whilst a ‘junk bond’ will incur higher fees of 3% or more.
Secondly, professional fees, namely for legal advice or for consulting if required to help organise the financing instrument. These fees add up quicly and represent many crore.
Lastly, do not forget the taxman, with two duties on NCDs: a registration fee and a stamp duty.
Given its success, it would come as no surprise if TCL were to repeat this operation in the future. And perhaps that will help to stimulate the relatively dormant market for corporate bonds in India, concludes professor Pandey.
