What Is Compulsory Convertible Debenture (CCD)?
Compulsory Convertible Debenture (CCD) is a type of debenture in which the whole value of the debenture must be converted into equity by a specified time. A CCD can be classified as a hybrid security, meaning it is neither considered pure debit nor pure equity.
Understanding Compulsory Convertible Debenture (CCD)
A debenture is a medium- to long-term debt security issued by companies to borrow money from investors at a fixed interest rate, though they are not secured by physical assets or collateral. These instruments are only backed by the full faith and credit of the issuing company. In effect, an unsecured corporate bond is a debenture. Debenture holders receive interest payments periodically, and are repaid by their principal investment at maturity.
A debenture comes in two forms – non-convertible and convertible. A non-convertible debenture is one that cannot be converted into the equity shares of the issuing company. Since there’s no convertibility feature on these types of debentures, the interest rate attached to them is higher than convertible debentures. Convertible debentures, on the other hand, can be converted into the company’s equity after a predetermined period of time. Since there is a perceived advantage of converting these fixed income securities into an ownership stake in the firm, investors are willing to accept a lower interest rate for purchasing convertible debentures.
One form of convertible debentures is the compulsory convertible debentures (CCD). The main difference between compulsory convertible debentures and other convertible securities is that owners of the CCD must convert their debentures into equity, whereas in other types of convertible securities, the owners of the debenture are given the option to convert. Debenture holders have no rights to vote in the company's general meetings of shareholders, but once the compulsory convertible debenture is converted into equity shares, the debenture holders automatically become shareholders in the company and acquire all the rights of shareholders.
The compulsory conversion of debentures to equity is, in fact, a method used by a company to pay off its debt by paying its debenture holders in kind, that is, equity. The payment in kind consists of repayment of principal and payment of interest. There are two types of conversion prices. The first conversion price would limit the price to the equivalent of the security’s par value back in shares. The second would delimit where the investor will earn more than par. The compulsory convertible debenture's ratio of conversion is decided by the issuer when the debenture is issued. The conversion ratio is the number of shares each debenture converts in to, and it may be expressed per bond or on a per centum (per 100) basis.
Some CCDs, which are usually considered equity, are structured in a manner that makes them more like debt. Often, the investor has a put option which requires the issuing companies to buy back shares at a fixed price. Unlike pure debt issues, such as corporate bonds, compulsory convertible debentures do not pose a credit risk later for the company issuing them since they eventually convert to equity. In addition, CCDs also mitigate some of the downward pressure a pure equity issuance would place on the underlying stock since they are not immediately converted to shares.