Accountingly speaking, a company is a mountain of money. Here's what the fundamental accounting formula tells us:
A = From the English Assets which is the Asset of the company, or the company itself.
L = Liabilities , which are the company's debts .
E = Equity which in English means capital of the partners.
What is Social Heritage (Equity): all the partners' capital invested in the company, including retained earnings.
What are debts (Liabilities): all accounts payable, all accounts with suppliers, all debts with banks, all private debts , all taxes payable, among others. Note that I made a point of differentiating debts with banks from private debts . Bank debts are usually more expensive and more restrictive, that is, they lend a smaller volume of capital and still charge more. Private debt , on the other hand, and here our debentures come in, are generally less restrictive and have a more attractive cost for the company.
What is the capital structure of any company?
Therefore, a company is constituted only by two types of capital: capital arising from debts (L) and capital arising from the partners (E) . When we say that a company is heavily indebted, we can say that L is greater than E.
An aggressively indebted company has an L greater than an E.
In contrast, a conservatively financed company has L less than E as we see in the following scheme.
A conservatively indebted firm has an E greater than an L.
With this brief explanation, it is clear that debentures enter the capital structure at the level of debts. We have that the ratio of Debt (L) to Share Capital (E) makes a company more or less conservative.
D/E > 1 The company has more debt than share capital, so it is aggressively funded .
D/E< 1 The company has less Debt than Share Capital, therefore it is conservatively financed .
What is a debenture?
A debenture is a title that a company issues to raise funds from third parties. When the investor buys this security, the company receives the money and is obliged to return it with interest. Therefore, a debenture holder is a creditor of the company and not its partner.
Who buys debentures?
The biggest consumers of debentures are pension funds , institutional investors, insurance companies, large banks, and individual investors.
How does a debenture work?
Usually a company issues a debenture because it needs capital to expand its operations, on the other hand a debenture holder seeks this type of investment to obtain some return on its capital. Debenture investments have a beginning: the day you invest, a middle: which is the interest you earn over time, and an end: the maturity date on which the money is returned.
Image 1: Scheme of payments and receipts of a Debenture. Source: NTN-B T-Gov
In the figure above we have the payment scheme for a debenture, (which is similar to the NTN-B). Let's imagine that the down arrows are all that come out of your pocket as an investor, and the up arrows are all you get over time.
Amount invested : As we see on the purchase date, there is a disbursement by the investor. How much does he pay? The Unit Price (PU) value for a security.
Coupon: At each period there is an interest receipt , which we call Coupon . In order to clarify, there is the receipt of an amount that will be deposited in the investor's checking account . In our example above, 6% per year is equivalent to 2.9% per semester. Are the coupons always semi-annual? No, sometimes we can find monthly or even annual payments.
Maturity Date : On this date, the company must return the invested amount to the investor plus the correction for the period . That is, if the shares are linked to inflation (IPCA+) the investor must receive the amount invested (Pu) adjusted for inflation. Is it always corrected for inflation? Not always. Technically any other index can be used as an index , but the most common are inflation (IPCA) and the Selic rate (CDI).
Debenture in practice
Enough talk, let's get right to a practical example. Call your manager and ask him to send you a list of currently available bonds. Remembering that not all banks offer this option. For example, I received this list from my manager at Banco do Brasil.
Table 1 - Card of debentures available for CPF investor in BB.
Above we see the Card of debentures available and marketed, notice the huge range of options that the investor has at his disposal. Let's analyze this Card column by column.
- In the first column we see the name of the issuing company , some companies are known, however, other names you may never have heard of.
- In the second column we have the B3 code of the title in question. This second column seems to be almost disposable information, but it is from there that we can investigate more about the emission. If you are curious about the topic, I leave the link here.
- The third column is reserved for the indexer , which is nothing more than the correction that the titles will receive over time. For example, if you bought an inflation-indexed bond for R$1,000.00 and the accumulated inflation until maturity of the bond is 37%, you will receive R$1,370.00 on the maturity day. The two most common indexes are the IPCA and the CDI.
- The fourth column is the bond purchase rate . I'm going to make an incorrect statement here, but for the average investor, for whom I write, it will be enough to understand the concept. The fourth column is basically the annual remuneration that the investor will receive in his account.
- The fifth column is the company's risk rating , theoretically the higher the risk the higher the rate should be. But it doesn't always work that way because the rates basically depend on the popularity of the company. See table 3 below.
- The sixth column is the expiration date, here you check the date you will receive your money back plus the index correction.
- The seventh column is the Unit Price (PU) of the debenture in question. It's the price you'll pay for a single paper today. Obviously this price varies over time.
- The eighth column is where we get the information if the debenture is exempt from income tax or not. In the case of exempt , the famous incentive debentures, they are free of income tax. Why are they encouraged? Because the government grants a tax benefit in certain areas of development that it considers strategic for Brazil. If the debenture is not incentivized then it suffers income tax taxation according to the regressive table .
Table 2 - Income Tax (IR) regressive table
9. The ninth column is the BB internal code.
10. The tenth column is the number of debentures available for sale. Looking through this column, we see that many debentures have a limited number for sale, as is the case with Light , which currently has only 47 shares for sale.
11. The last column is the sector in which the company that is issuing the debenture operates.
What are the risks of a debenture?
The main risks of a debenture are liquidity and credit.
Liquidity Risk is the risk of not finding buyers for our security at a fair price . If halfway through you want to “get out” of a debenture, you will have to try to sell it on the secondary market and you may not find a buyer for your debenture. In the case of Banco do Brasil, I have “firm offers” , that is, they are securities whose repurchase is guaranteed by the Bank's treasury. However, nothing is free, so expect some cost to perform this operation.
Credit Risk : It is the risk of the company going bankrupt and not honoring its debts. Some debentures are unsecured , that is, they do not have guarantees. Others companies provide debentures with real guarantees , such as, for example, real estate. However, I consider any and all debentures "as it were" unsecured , as I don't want to get caught rushing to liquidate my position with a company that went bankrupt. The key here is to avoid confusion.
Table 3: Risk classification of debentures, Source: bndes.gov.br
When we analyze the debentures for sale at BB, we see that the bank only sells companies with an exceptional or excellent financial situation . However, as much as our fifth column on the card is filled with AAA s (low risk companies), never fail to assess the company's financial health , read the prospectuses, investigate some news on Google, that is, do your homework .
Debenture worth it?
If you are looking for exorbitant gains, unfortunately debentures are not for you. These Corporate Credit Papers are intended for investors seeking income and capital gains consistent with reality. How much income ? 3% to 10% pa would be the yield range for this type of investment. How much capital gain ? Usually inflation. Therefore, debentures represent a great investment opportunity as long as the investor respects the maturity date and performs the proper quality checks on the issuing company.
To think about
- Is there a premium sale on debentures?