Non-Convertible Debentures (NCDs)

Non-convertible debentures (NCDs) are fixed-income securities issued by high-rated companies to raise long-term capital through public offerings. They usually offer higher interest rates than convertible debentures. Individuals, banks, primary dealers, and registered companies or unincorporated bodies in India can invest in NCDs.

What are non-convertible debentures?

Non-convertible debentures (NCDs) are fixed-income instruments that are usually issued by high-rated companies in the form of a public issue to accumulate long-term capital appreciation. They are a type of debt instrument that cannot be converted into equity or stocks. NCDs have a fixed maturity date and the interest can be paid along with the principal amount either monthly, quarterly, or annually depending on the fixed tenure specified. They offer relatively higher interest rates when compared to convertible debentures.

NCDs are backed by the creditworthiness of the issuer and are not backed by any collateral. Interest pay-outs are either monthly, quarterly, half-yearly, or annually. NCDs do offer a cumulative payout option as well.

Investors should consider the credit rating of the issuer before investing in NCDs. Companies are ranked by credit rating agencies such as CRISIL, CARE, etc. A higher credit rating means that the company has the ability to fulfil credit obligations. However, a low credit rating means that the company has high credit risks involved. If any issuing company fails to make payments, then the rating agencies give them a lesser ranking.

Types of NCDs

There are two types of non-convertible debentures:

1. Secured NCDs:

Secured non-convertible debentures are a type of debt instrument where the issuer provides specific assets as collateral to secure the investment made by the debenture holders. In the event of a default by the issuer, the debenture holders have a claim on the specified assets pledged as collateral. This added layer of security makes secured NCDs less risky compared to unsecured counterparts.

Key features:

• Collateralised security: Secured NCDs are backed by tangible assets, such as properties, plants and machinery, or any other specified assets, which provide a safety net for investors.
• Lower risk: The presence of collateral reduces the risk for investors, as they have a claim on the underlying assets in case of default.

Investor considerations:

• Investors often find secured NCDs attractive due to the lower risk associated with the presence of collateral.
• Interest rates on secured NCDs may be slightly lower than those on unsecured NCDs, reflecting the reduced risk for investors.

2. Unsecured NCDs:

Unsecured non-convertible debentures do not have any specific assets pledged as collateral. Investors in unsecured NCDs rely solely on the creditworthiness and repayment capacity of the issuing corporation.

Key features:

• No collateral: Unsecured NCDs lack the backing of specific assets, making them riskier compared to secured NCDs.
• Higher risk-reward profile: Due to the absence of collateral, unsecured NCDs generally offer higher interest rates to compensate investors for the increased risk.

Investor considerations:

• Investors seeking potentially higher returns may be attracted to unsecured NCDs, but they should be aware of the higher risk involved.
• Credit rating assessments become crucial for investors in unsecured NCDs, as they rely heavily on the financial health and creditworthiness of the issuing corporation.

The choice between secured and unsecured NCDs depends on an investor's risk tolerance, return expectations, and the level of security they seek in their investment portfolio. It is essential for investors to conduct thorough due diligence, including assessing the credit rating of the issuing corporation, before making investment decisions in the Indian securities market.

Features of non-convertible debentures

Below are the key features of NCDs:

1. Credit rating
   Credit rating agencies such as CRISIL, CARE, etc., rank companies based on their creditworthiness. A higher credit rating means that the company has the ability to fulfil credit obligations. However, a low credit rating means that the company has high credit risks involved. If any issuing company fails to make payments, then the rating agencies give them a lesser ranking.
2. Interest
   NCDs have a fixed maturity date and the interest can be paid along with the principal amount either monthly, quarterly, or annually depending on the fixed tenure specified. They offer relatively higher interest rates when compared to convertible debentures. Interest payouts are either monthly, quarterly, half-yearly, or annually. NCDs do offer a cumulative payout option as well. Moreover, unsecured NCDs can offer a higher interest rate.
3. Issuance
   NCDs are made available to investors through open-market public issues conducted by companies within defined periods. Interested investors can purchase these debentures during the specified timeframe, contributing to the company's capital-raising efforts.
4. Tradable securities
   Non-Convertible Debentures are actively traded in the stock market. This tradability provides investors with the flexibility to buy or sell NCDs in the secondary market, enhancing market liquidity and allowing investors to manage their portfolios dynamically.
5. Credit rating
   Given that NCDs lack collateral backing, only companies with robust credit ratings can issue them. These credit ratings, regularly assessed by credit rating agencies, serve as a crucial determinant of an issuer's ability to fulfill credit obligations. This underscores the importance of creditworthiness in the issuance and investment in non-convertible debentures.

Who can invest in Non-Convertible Debentures (NCDs)?

NCDs cater to a diverse investor base segmented into three categories:

1. Category I (Institutional Investors):

Includes entities such as:

• Banks (commercial, cooperative, and regional rural)
• Public financial institutions (e.g., LIC, GIC, UTI)
• Mutual funds and insurance companies
• Pension funds and venture capital funds
• Foreign portfolio investors and national investment funds

2. Category II (Non-Institutional Investors):

Comprising:

• Corporates, trusts, and charitable organisations
• High Net Worth Individuals (HNIs)
• Research organisations and partnership firms, provided they are authorised to invest

3. Category III (Individual Investors):

Includes:

• Resident Indians
• Hindu Undivided Families (HUFs)
• Non-Resident Indians (NRIs), subject to regulatory approvals

Investors must ensure they meet issuer and regulatory eligibility requirements. Certain individuals, such as minors and specific foreign entities, may not be eligible to invest.

How to purchase NCDs?

The issuing company commences a public offering of its Non-Convertible Debentures (NCDs) for a predetermined duration. Following the conclusion of this offering, the NCDs are listed on a designated stock exchange, as specified by the company. Once listed, investors can acquire these NCDs through registered brokers or other authorised channels that provide access to the stock exchange.

Things an investor should consider before investing in NCDs

Let us know what an investor should consider before investing in NCDs:

1. Level of debt

The level of debt of the issuing company is an important factor to consider. If the company has a high level of debt, it may not be able to service its debt obligations in the future. Therefore, it is important to check the debt-to-equity ratio of the company before investing in its NCDs.

2. Capital adequacy ratio (CAR)

CAR is a measure of a bank’s capital in relation to its risk-weighted assets. It is an important indicator of a bank’s financial strength and stability. A higher CAR indicates that the bank has a strong capital base and is better equipped to absorb losses. Therefore, it is important to check the CAR of the issuing bank before investing in its NCDs.

3. Provisions for non-performing assets

Non-performing assets (NPAs) are loans or advances that are in default or are in arrears. It is important to check the provisions made by the issuing company for NPAs. Higher provisions indicate that the company is better prepared to handle NPAs.

4. Interest coverage ratio

Interest coverage ratio (ICR) is a measure of a company’s ability to meet its interest obligations. It is calculated by dividing the earnings before interest and taxes (EBIT) by the interest expense. A higher ICR indicates that the company is better equipped to service its debt obligations. Therefore, it is important to check the ICR of the issuing company before investing in its NCDs.

Benefits of non-convertible debentures

1. Fixed returns:
   NCDs offer predictable returns, making them suitable for investors seeking stability.
2. Diversification:
   By investing in NCDs issued by different companies and industries, investors can reduce risk through diversification.
3. Higher returns:
   NCDs generally provide higher returns compared to traditional fixed-income instruments like bank fixed deposits.
4. Tax benefits:
   Interest earned on NCDs is taxed at a lower rate of 10%, making them a tax-efficient investment choice.
5. Liquidity:
   The tradability of NCDs on stock exchanges ensures liquidity, allowing investors to exit their investments if needed.
6. Credit rating insight:
   Credit ratings help investors assess the creditworthiness of issuers and manage risks effectively.
7. Tenure flexibility:
   NCDs are available in various tenures, enabling investors to align investments with their financial goals.

Corporate fixed deposits vs. non-convertible debentures

Let us understand the key differences between fixed deposits and non-convertible debentures:

Feature	Corporate fixed deposits (FDs)	Non-convertible debentures (NCDs)
Issuer	Banks of financial institutions	Corporations
Interest rate	Fixed	Fixed or floating
Liquidity	Less liquid	More liquid (traded in stock market)
Market risk	Minimal (no market risk)	Market risk due to interest rate fluctuations
Tenure	Fixed tenure	Specific term with interest rate
Taxation	Taxed as per investor's income tax slab rate	Tax implications depend on the investor's tax bracket, with different rates for STCG and LTCG. Interest income is taxed similarly to fixed income securities.

Conclusion

Non-convertible debentures (NCDs) offer investors a fixed-income avenue with varying risk profiles. Whether you opt for secured or unsecured NCDs, it is crucial to conduct thorough research and understand the features and risks associated with each type. Diversification, careful assessment of credit ratings, and staying informed about market conditions are key elements for making informed investment decisions. As with any investment, it is advisable to consult with financial advisers to tailor your NCD investments to your financial goals and risk tolerance. By incorporating these tips into your investment strategy, you can make well-informed decisions and potentially enhance the overall stability and returns of your investment portfolio

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