What are Non-Convertible Debentures (NCDs)
Debentures are called non-convertible when they cannot be converted into equity. Categorized as fixed income instruments, NCDs are long-term financial instruments used to build capital for the long run. Companies issue debentures for raising funds from the public domain at a fixed interest rate.
The Reserve Bank of India defines non-convertible debentures as negotiable monetary instruments with a minimum maturity period of 90 days. Both banks and non-banking financial corporations can be issuing company. Non-convertible debentures feature a fixed maturity date and offer attractive returns to investors. Investors are liable to receive returns based on the issuer’s terms and, on maturity, receive the principal amount and returns based on the current interest rate.
Unlike their convertible counterparts, non-convertible debentures cannot metamorphose into securities such as shares or equities. While that may seem like a limitation, NCDs boast a few striking features, such as a high-interest rate & liquidity, which offer an array of benefits to both owners & investors.
Let’s look at the features & perks that make non-convertible debentures so lucrative to investors all over.
Types of NCDs (Non Convertible Debentures)
Secured NCDs: Secured by company assets & other collateral, these debentures offer better safety to investors. They can liquefy the assets & collateral if the company fails to fulfill its debt obligations. However, secured NCDs have lower interest rates.
Unsecured NCDs: Unsecured non-convertible debentures have no backing from the issuing company’s assets. If they fail to deliver, investors have no choice but to wait for their payments. On the plus side, unsecured NCDs boast of higher interest rates.
Features Of Non-Convertible Debentures
Despite their inability to convert into equity shares, non-convertible debentures exhibit some remarkable features.
Any entity can subscribe to non-convertible debentures in either the primary or the secondary securities market. The Reserve Bank of India allows both residents & non-residents to invest in this debt instrument.
Most NCDs are public issues in the secondary market, and investors can buy them through registered brokers.
Their availability in the stock market boosts the liquidity of non-convertible debentures. In addition, NCDs must be listed on the secondary market per RBI regulations and are generally considered more liquid than bank fixed deposits.
3. Interest Rate
Non-convertible debentures harbour high, fixed interest rates even higher than that of fixed deposits. Variable interest payout options exist and are done monthly, quarterly, or yearly. Attractive payouts are the most significant reason behind their prominence.
NCDs also offer a cumulative payout option to subscribers, making them an excellent investment vehicle across varied demographics.
The minimum maturity period of an NCD is 90 days, while the maximum tenure can be as high as 20 years. With such variability in their maturity periods, NCDs offer immense flexibility to their subscribers.
The taxation rules associated with NCDs are akin to debt & fixed income instruments taxation. There are no taxes deducted at the source.
Short-term capital gains (STCG) deductions are applicable per the investor’s income tax slab rate if they sell their non-convertible debenture within one year. Long-term capital gain (LTCG) deductions of 10% (20% come into the picture if NCDs are sold after 3 years.
6. Credit rating
The credit rating of the debenture issuing company is a crucial metric that investors must pay heed to.
Eligible NCD issuers must have approval from official credit rating agencies such as CRISIL, CARE, etc. Companies with more than ₹1000 crore require approval from two different agencies. Non-convertible debentures from companies with good credit ratings are more secure as they exhibit more creditworthiness and are more likely to fulfill their credit obligations to investors.
Advantages of Investing in Non-Convertible Debentures
Investing in NCDs comes with a range of superb benefits.
- The high-interest rate, higher than even fixed financial instruments/deposits, is their most prominent benefit.
- Stock exchange listing makes an NCD a financial instrument of high liquidity. This is because NCDs lie in between bonds & equities in terms of liquidity. Therefore, investors can buy & sell quickly on the stock market.
- Corporate organizations issuing non-convertible debentures are reviewed & monitored by leading rating agencies, as per RBI regulations.
- Tax benefits are another significant reason as NCDs are not eligible for TDS.
The above benefits are in no way meagre and make NCDs an attractive & ideal investment vehicle. However, non-convertible debentures are also subject to market risks. Therefore, one must exercise caution and pay heed to the following factors before investing.
Factors To Consider Before Investing In Non-Convertible Debentures
If you are looking for a handsome interest income from an NCD, keep the following points in mind.
1. Credit Rating Of The Issuer
A company’s credit rating is one of the first things one must check out. Official bodies assign credit ratings, and it is best to buy NCDs from firms with high ratings from multiple credit rating agencies. A higher credit rating means lower risks, while low ratings indicate higher credit risk.
2. Debt Level
Always look into the company’s debt obligation history. Besides credit rating, do a thorough background check look at their past performance, and find out if they have a history of defaulting on their interest payments. In addition, find out more about the company’s debt-equity ratio, level of unsecured loans, and asset allocation.
3. Capital Adequacy Ratio
This ratio indicates the ability of an NCD issuer to sustain major losses. As a result, they are vulnerable to business risks & economic downturns. Check out the history of a company’s capital adequacy ratio before taking any decision.
4. Provisions For Non-Performing Assets
Companies looking to raise long-term capital using NCDs must be able to maintain at least 50% of their provisions for non-performing assets. This reduces investor risks and indicates better debt obligation.
5. Interest Coverage Ratio
The interest coverage ratio indicates the capability of a company to repay debts even under stress. Therefore, a higher interest coverage ratio depicts a healthy financial position.
The interest earned, the fixed rate, and the lure of more money can make NCD investments incredibly alluring.
Invest in a company with a good credit rating, read the scheme-related documents carefully, review the company’s financial statements and keep in mind the factors above before investing.
Yes, it is. Just make sure you check the issuer company’s assets, offer document, and credit ratings, and be clear about the goals of your investment ideas.
Bonds are secured by assets, while NCDs are generally unsecured by any asset or collateral. However, bonds have lower interest rates than NCDs.
Big companies such as central banks and major NBFCs issue NCDs publicly on the stock exchange to raise funds. Once listed, you can buy them through registered brokers.