Why Companies Raise New Debt to Refinance Existing NCDs? [Example: Embassy Office Parks REIT]

Recently I read a news about Embassy Office Parks REIT. The company announced that it has raised Rs. 2,000 crore through coupon-bearing debt at an interest rate of around 7.95%. The REIT plans to use the funds to repay its Non-Convertible Debentures (NCDs) worth Rs.2,000 crore. The NCDs are maturing in October 2024. This is a classic example of debt refinancing or, more specifically, taking new debt to repay maturing debt obligations.In this blog, we’ll dive into why companies like Embassy Office Parks REIT opt for such strategies. I wil explain how it works, and whether this approach is commonly seen in the corporate world.Topics:1. Why So Much Capital Requirement?When a company like Embassy Office Parks raises Rs.2,000 crore through NCDs, they typically use the funds for acquiring or developing new properties, or funding major infrastructure projects.In the case of REITs like Embassy, the money is used to expand their commercial real estate portfolio. The money can also be partly used to improve existing assets.These large sums are crucial for maintaining growth and securing future revenue streams through leasing or rental income.2. What is an NCD, and Why Does It Mature?To understand the context of this strategy, let’s start by defining Non-Convertible Debentures (NCDs).NCDs are debt instruments that companies issue to raise capital.NCDs come with a fixed tenure, during which the company is obliged to pay regular interest to the debenture holders. Unlike convertible debentures, NCDs do not convert into equity shares at maturity.Instead, the company must repay the principal amount borrowed once the NCD matures.Embassy Office Parks REIT had raised ₹2,000 crore earlier by issuing NCDs. These NCDs are set to mature in October 2024. Upon maturity, the company is required to repay this amount to its debenture holders.This is where their new debt comes in.2.1 How NCDs Work?In this example, Embassy Office Parks REIT is the borrower. They raise money by issuing NCDs (Non-Convertible Debentures), which are bought by investors.The money paid by these investors goes to Embassy Office, which they can then use for their business needs.2.2 How a Company Raises Funds Through NCDs: StepsLet’s say Embassy Office wants to raise Rs.2,000 crore. Instead of going to a bank for a loan, they decide to issue NCDs to the public or institutional investors.Here’s how it works:Company Decides to Issue NCDs: Embassy Office decides they need funds for expansion, debt repayment, or other purposes. They choose to issue NCDs, a form of debt that gives investors fixed interest payments over time.Getting Approval: Embassy Office needs approval from its board and regulatory authorities, like SEBI (Securities and Exchange Board of India), because NCDs are regulated financial instruments. They also need a credit rating from agencies like CRISIL or ICRA, which tells investors how risky or safe it is to invest in their NCDs.Offering the NCDs: Once they have approvals and a good credit rating, Embassy announces their NCD offering to the public or institutional investors. They provide details like the interest rate (coupon rate), maturity date, and how the NCDs will be repaid (lump sum or installments). For example, they may offer an interest rate of 7.95% for a 5-year NCD. Investors know they will receive 7.95% interest annually on the money they invest. Plus, their original investment will come back when the NCD matures.Return to Investors: Institutional investors (like mutual funds or insurance companies) or individual investors buy the NCDs. Let’s say an individual investor buys Rs.10 lakhs worth of NCDs. That investor will receive annual interest payments from Embassy Office at 7.95% until the NCD matures.Embassy Receives the Money: The money from the sale of these NCDs (in this case, Rs.2,000 crore) goes to Embassy Office. They can now use it to repay existing debt (like maturing NCDs) or for other business activities.Repaying the NCD: Over time, Embassy Office pays the fixed interest to the NCD holders. At the end of the NCD’s tenure (for example, 5 years), they will return the principal amount to the investors, completing the repayment.When a company wants to raise funds through NCDs, they typically hire investment banks or merchant bankers. These agencies assist with structuring the NCDs, getting credit ratings, regulatory approvals, and finding investors.For example, when a TATA Group company issued NCDs, they worked with agencies like ICICI Securities and Edelweiss Financial Services.3. Why Do Companies Like Embassy Office Parks REIT Choose NCDs for Debt Financing?Non-Convertible Debentures (NCDs) are a popular choice for companies when it comes to raising debt for several reasons:Long-Term Funding: NCDs allow companies to secure long-term funding without diluting equity. Real estate companies often have long-term projects. Hence, NCDs are a good fit for their financing needs. Instead of relying on short-term loans that need constant rollover, NCDs provide more predictable, structured debt with a clear timeline for repayment.Flexibility in Terms: Issuing NCDs gives the company flexibility in deciding the tenure, interest rate, and repayment terms. This allows them to structure the debt in a way that aligns with their future cash flows, making it more manageable.Fixed Interest Payments: With NCDs, interest payments are fixed over the duration of the debt, making them easier to budget for. Unlike variable-rate loans, companies know exactly what their cost of debt will be. It helps them plan better for their financial commitments.No Immediate Pressure on Cash Flow: NCDs often have bullet payments (repayment of the principal in one lump sum at the end of the tenure). This gives companies more time to use their capital for other purposes before they need to repay the debt. For a REIT, this is beneficial because their revenue might not be immediately available. Given the long-term nature of property leasing and rental income.3.1 A Comparison Between NCD vs Long Term Bank Loan FeatureNon-Convertible Debentures (NCDs)Long-Term Bank LoanAdvantages / Disadvantages of NCDsSource of FundingRaised from public or institutional investors via bond marketsProvided by banks or financial institutionsNCDs tap into a wider investor base, providing more flexibility.Interest RateTypically fixed throughout the tenureCan be fixed or floating (linked to repo rates or bank’s MCLR)Fixed rates offer better predictability with NCDs.RepaymentUsually at the end of tenure in a lump sum (bullet payment)Can have structured EMIs (monthly/quarterly) for principal and interestNCDs allow companies to avoid frequent repayments, preserving cash flow.TenureGenerally medium to long term (3 to 10 years)Flexible tenure based on bank terms, but often shorter for SMEsLonger tenure available with NCDs can suit capital-heavy industries.Collateral RequirementUsually unsecured (depending on the company’s credit rating)Often requires collateral, especially for large amountsNCDs are often unsecured, freeing up assets for other financing needs.Issuance ProcessRequires regulatory approval and credit rating; public offeringQuicker approval process with banks, but stringent documentationRegulator involvement makes NCD route more complexCost of BorrowingGenerally lower due to access to a broader capital marketHigher, especially for businesses with lower credit ratingsNCDs may offer lower interest rates for well-rated companies.Prepayment PenaltyNo prepayment options for most NCDsMay include prepayment options but with penaltyCompanies cannot prepay their NCDs even if they wantInvestor TypeInstitutional and retail investorsBank or financial institutionBroader investor base reduces reliance on a single lender.Regulatory OversightSEBI-regulated for listed NCDsRBI-regulatedNCDs follow market-based regulations, offering more transparency.4. Why Opt for NCDs Even If Repayment Requires New Debt?If a company anticipates that it might need to take on new debt to repay the NCDs upon maturity, you might wonder why it still chooses this option.The answer lies in the strategic advantages NCDs offer, despite the future need for refinancing.Matching Debt with Long-Term Cash Flow: Companies like Embassy Office Parks REIT are involved in a capital-intensive sector. Here, projects take years to generate revenue. NCDs with longer maturities allow the company to align its debt repayments with the expected cash inflows. The inflows will only come with long-term lease agreements or property sales. There are many years in between a project start and lease agreements starting to flow-in.Managing Interest Rate Risks: Issuing NCDs at a fixed coupon rate can protect the company from future interest rate volatility. This is especially true in a low interest regime. After COVID, interests rates on loans became very low. Even if they have to refinance later, the fixed rate of the NCD offers stability in interest payments for the duration of the debt. This is often seen as a better strategy than floating-rate loans, which can become more expensive if rates rise.Building Investor Confidence: Issuing NCDs is often part of a broader debt strategy to build investor confidence. When large companies issue NCDs, they signal stability and transparency to the market. Institutional investors, who generally favor predictable returns, tend to prefer NCDs. This opens up a broader range of investors, giving the company access to more capital.Optimizing Cost of Capital: Even if refinancing is anticipated, the cost of raising funds through NCDs can be more favorable compared to other debt instruments like bank loans. NCDs often have lower interest rates than traditional bank loans, especially if the company has a good credit rating. This reduces the cost of borrowing for the company, making it more attractive.5. Why Take New Debt to Repay Old Debt?Embassy Office Parks REIT is taking on new debt to repay the maturing NCDs. This practice is commonly referred to as debt refinancing.It might seem counterintuitive to us at first glance to take on more debt when you already have debt obligations. There are several strategic reasons why companies choose this route:5.1 Managing Cash FlowOne of the primary reasons companies opt for refinancing is to avoid large lump-sum payments.Maturing NCDs, especially large amounts like Rs.2,000 crore, can strain a company’s cash reserves.By taking on new debt, companies can spread the repayment over a longer period, easing the immediate burden on cash flow.5.2 Taking Advantage of Favorable Interest RatesInterest rates fluctuate over time based on macroeconomic factors such as inflation, demand for credit, and central bank policies.If current interest rates are lower than those of the maturing debt, it can make sense for companies to issue new debt at a lower rate.In Embassy’s case, the new debt has a coupon rate of 7.95%. If this is lower than the interest rate on the maturing NCDs, the company could reduce its interest costs over time.5.3 Maintaining CreditworthinessCompanies are often assessed by credit rating agencies based on their ability to meet debt obligations.By ensuring timely repayment of maturing debt through refinancing, a company can maintain or even improve its credit rating.This, in turn, can lead to better access to capital markets in the future, along with lower borrowing costs.5.4 Preserving Capital for GrowthTaking new debt to repay old debt also allows companies to preserve their capital for other growth-oriented initiatives.Instead of using reserves to repay maturing NCDs, a company like Embassy Office Parks REIT can retain those funds. These funds can then be used for investing in its property portfolio or other strategic ventures.6. Is Refinancing of Debt A Common Practice?Yes, refinancing debt by issuing new debt is a common phenomenon, not just in India but globally.Many companies and even governments regularly use this strategy to manage their debt obligations.Here are some examples of where this is frequently seen:6.1 Corporate SectorIn the corporate world, refinancing is often used when companies have substantial maturing debt.Companies in industries such as real estate, infrastructure, and utilities—sectors that often have long-term capital needs—use this strategy. It is done to maintain liquidity while continuing to service their obligations.For instance, real estate companies, which tend to have long-term projects, frequently resort to refinancing to avoid large repayments at one go.Embassy Office Parks REIT’s strategy of issuing new debt to repay maturing NCDs fits within this framework.Remember, it may taking debt to repay old debt may not be a standard case. It is especially beneficial for companies like REITs whose investments are of capital-intensive nature.6.2 Government DebtEven governments engage in debt refinancing.When bonds issued by governments reach maturity, they often issue new bonds to repay the old ones, essentially rolling over the debt.This helps them manage their fiscal deficits without putting immediate pressure on tax revenues or borrowing from other sources.6.3 Household and Personal FinanceOn a smaller scale, individuals also practice refinancing.For example, homeowners may refinance their mortgages to take advantage of lower interest rates or to change the terms of their loan.This is done to reduce monthly EMI payments or shorten the loan tenure.ConclusionEmbassy Office Parks REIT’s decision to raise Rs.2,000 crore in debt to repay maturing NCDs can be a calculated step to managing its financial obligations.By refinancing, the company ensures that it can meet its debt commitments without disrupting cash flow. I’m not sure at what cost (interest rates) the NCDs were issued, but if the new debt offers costs less interest, it good. It will reduce its interest expenses, and preserve capital for future growth.This approach is common among companies with significant capital needs.