What Is a Compulsory Convertible Debenture (CCD)?
A compulsory convertible debenture (CCD) is a type of bond which must be converted into stock by a specified date. It is classified as a hybrid security, as it is neither purely a bond nor purely a stock.
A debenture is a medium- to long-term debt security issued by a company as a means of borrowing money at a fixed interest rate. Unlike most investment-grade corporate bonds, it is not secured by collateral. It is backed only by the full faith and credit of the issuing company.
In effect, an unsecured corporate bond is a debenture.
Understanding the CCD
A debenture comes in two forms – non-convertible and convertible:
- A non-convertible debenture cannot be converted into equity shares of the issuing company. Instead, debenture holders receive periodic interest payments and get back their principal at the maturity date, just like most bondholders. The interest rate attached to them is higher than for convertible debentures.
- Convertible debentures may be converted into the company’s equity after a set period of time. That convertibility is a perceived advantage, so investors are willing to accept a lower interest rate for purchasing convertible debentures.
The CCD is one form of the convertible debenture. The difference is that its owner must accept stock in the company when it matures rather than having the option of receiving stock or cash.
- A compulsory convertible debenture is a bond that must be converted into stock at its maturity date.
- For companies, it allows for repayment of debt without spending cash.
- For investors, it offers a return in interest and, later, ownership of shares in the company.
Debenture holders have no rights to vote as shareholders until their debentures are converted into shares.
For companies, the compulsory conversion of debentures to equity is a way to repay a debt without spending cash. It is payment in kind, consisting of repayment of principal and payment of interest.
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 can be expressed per bond or on a per centum (per 100) basis.
CCDs are hybrid securities, with some attributes of bonds and some like stocks.
There are two types of conversion prices. One limits the price to the equivalent of the security’s par value in shares. The second allows the investor to earn more than par value.
How CCDs Are Traded
CCDs are usually considered equity, but they are structured more like debt. The investor may have a put option which requires the issuing company 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 for the company issuing them since they eventually convert to equity. 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.