Can someone ELI5 the effects of debentures on company financials?


Too many questions, I’ll try to answer.

Firstly, NRB has been urging banks to issue debentures. Mandatory policy jastai cha, I forgot the exact numbers. So this is one of the reason why Banks are issuing debentures. Also for a bank, issuing debentures is not to use that money to give loans but more to back the loans by increasing capital. Because banks finance their loan from deposits, they simply have capital to back the loans/assets. For instance real example, I took vehicle loan at 7% and interest on debenture is 8.5%, this business models is not feasible for a bank. It can’t raise capital at 8.5% and give me loans at 7%. Banks issue loans from deposits and not capital. Unlike a manufacturing company, which uses capital raised from debentures/bonds to invest in assets, banks isse them to meet the capital requirement and not necessarily to issue loan from it.

FD rates will always be lower to debentures. Debentures are risky in comparison to FD. Moreover for a bank, debentures are subordinate to deposits. So in case of bankruptcy, depositors get their money first then debenture holders. Also deposits are backed by insurance polices as well, hence low risk. If debentures rate were lower than FD, why would anyone invest in debenture? Also since the NRB has a policy is place that mandates banks to issue debentures, they must be able to sell the debt instruments by increasing %.

Debt reduces tax burden because interest expenses are tax deductible.

Debentures are tier 2 capital of a bank. The more the assets /loans, then more capital the bank requires. There is no direct relationship between CD ratio and debentures. CD depends upon deposits. Now banks issue credit to different sectors like retail, government, mortgage. The risk associated with retail loan is higher than mortgage hence if A bank has more retail loans and B has more mortgage, bank A must have higher capital than bank B because the investments of bank A is risky. So there isn’t a direct relationship between CD and debentures, but indirect cahi cha.

The debenture amount can be seen on liabilities side of the balance sheet. Debt securities issued ma.

The amount paid on debenture by the bank to debentures holders is the coupon rate times FV. Its an expense, on income statement. I think it’s included in the interest expense section under ‘interest on borrowing’.

As I said debentures are tier 2 capital. And banks needs it, so even if the current issued debentures are expired, banks will rollover and issue new debentures. Think of it this way, the more the bank grows, the more capital it needs and capital can come either by raising equity or debentures. So debentures redemption hudai ma dividend giving capacity increase huncha vanne hoina jaha samma malie lagcha.

The last question is kind of mix. And depends upon situation. Leverage usually increases EPS. If your question is that, will expiration of debenture the company doesn’t have to pay interest to debenture holders and then with low expenses the EPS increases? Then read the above paragraph.

In short, if you are an equity holder, high debt will increase ROE given that the debt is sustainable.

Most of these questions don’t have yes or no answers.

Correct me if I am wrong, it’s been a while since I have read about banking policies of Nepal.

Comments are closed.