How Different Types Of Non-Convertible Debentures Work In The Market
Companies can raise money using debentures without reducing ownership. Since debenture investment generates debt, investors who purchase them become the company’s creditors and receive periodic interest payments, known as coupons.
The two main types of debentures are Convertible and Non-Convertible Debentures (NCDs). NCD investments offer stable returns and help achieve effective portfolio diversification.
What Are Non-Convertible Debentures?
While convertible debentures are debt securities that can be converted into equity shares, non-convertible debentures (NCDs) cannot be exchanged for equity.
NCDs remain fixed-income instruments throughout their tenure, offering periodic interest payments that can be made monthly, quarterly, or annually. They also come with a predetermined maturity date.
Types Of Non-Convertible Debentures
Listed below are the two categories of NCD.
1. Secured Non-Convertible Debentures
Secured NCDs are deemed safer because the company's assets support their issuing. Investors may retrieve their money if the business doesn't make payments on schedule by selling off the company's assets. NCD interest rate in this case is less.
2. Unsecured Non-Convertible Debentures
Since unsecured NCDs are not backed by the issuer’s assets, they carry a higher level of risk compared to secured NCDs. To compensate for this added risk, unsecured NCDs typically offer higher interest rates than their secured counterparts.
Examples Of Non-Convertible Debentures
Here are the latest non-convertible debentures for the financial year 2024-25
Name | Issued on | Issue closes | Industry | Base issue size (INR Cr) |
Muthoot Fincorp Limited | 10-Apr-24 | 25-Apr-24 | NBFC | 100.00 |
ICL Fincorp Limited | 5-Apr-24 | 23-Apr-24 | NBFC | 75.00 |
Edelweiss Financial Services Limited | 7-Oct-24 | 18-Oct-24 | NBFC | 100.00 |
NIDO Home Finance Limited | 18-Sep-24 | 1-Oct-24 | NBFC | 50.00 |
Adani Enterprises Limited | 4-Sep-24 | 6-Sep-24 | NBFC | 400.00 |
Source: SEBI1
Key Features Of NCDs
The characteristics of the non-convertible debentures enhance investor understanding of the instrument. Attributes can help investors decide if they should invest in NCDs.
1. Rated Securities
Credit rating agencies such as CRISIL, CARE, and others evaluate non-convertible debentures (NCDs). These ratings play a crucial role in determining an NCD’s reliability. A higher credit rating indicates the company’s strong ability to meet its financial obligations, making it a safer investment option.
A poor credit rating indicates that the business is exposed to significant credit risks. The rating agencies provide a lower grade to any issuing firm that defaults on payments.
2. Non-Convertible Debentures Interest Rate
If investors hold non-convertible debentures (NCDs) until maturity, they can earn a substantial interest rate. NCDs offer flexibility, allowing interest payments in installments or as a cumulative payout at maturity. This makes them an attractive option for passive income generation. Additionally, unsecured NCDs may offer higher interest rates to compensate for the increased risk.
3. Issuance Of Non-Convertible Debentures
NCDs are offered by businesses through open-market public offerings, allowing investors to purchase them within a specified time. On the stock market, non-convertible debentures are traded.
4. Exchangeable securities
Non-convertible debentures are actively traded on the stock market, allowing investors the flexibility to buy and sell them as needed. This enhances market liquidity and enables portfolio diversification.
5. Companies with good rating
While NCD ratings range from AAA to D, they are typically issued by companies with investment-grade credit ratings. As per SEBI guidelines, an NCD should have an investment grade rating from at least one Credit Rating Agency2.
How To Invest In NCDs?
Now that the concept of non-convertible debentures is discussed, let us now move on to the steps involved in the purchase of NCDs.
Listed below are the actions that investors must follow in order to make NCD investments.
- Non-convertible debentures are first launched in the primary market.
- Similar to the shares, after the primary market operations, non-convertible debentures are openly traded in the secondary market.
- They get listed on stock exchanges like NSE and BSE, where they are exchangeable.
- Investors can invest in NCDs through brokerage platforms or banks.
Although the mechanism of investment in NCD seems easy, there are some important considerations before investing.
Things To Consider Before Buying Non-Convertible Debentures
Before investing in NCDs, investors should perform due diligence on certain parameters. Since the profitability of NCDs is directly proportional to the financial performance of a company, these company and market-specific factors can help make prudent decisions regarding the profitability of the investment.
1. Rating: CRISIL, CARE and other credit rating organisations provide a comprehensive guide to judging the credibility of NCD. The company's financial sustainability and capacity to generate revenue from both internal and external activities are established by its credit rating. Companies rated AA or above are safer than the others.
Rating | Description |
AAA | Highest safety with the lowest credit risk. |
AA | High safety and timely management of obligations. |
A | Adequate safety levels. |
BBB | Medium credit quality. |
BB | Moderate quality and default risk. |
B | Significant default risk. |
C | High default risk. |
D | Expected to default soon. Lowest safety. |
Source: CRISIL3
2. Capital Adequacy Ratio: CAR evaluates the company's capital to see whether it has enough money to withstand any losses. It can be available on websites, in regulatory filings, or financial accounts. A higher Capital Adequacy Ratio indicates a company's stronger ability to absorb losses. Regulatory bodies like the RBI have set minimum CAR requirements for different industries to ensure financial stability.
3. Interest Coverage Ratio: The firm's capacity to easily pay back the interest on its debts at any given moment is determined by ICR. This guarantees that the business can manage any evasions. A high ICR indicates a company is more comfortable paying back its loan.
Investors should look into other aspects of the financial statement to get a more comprehensive view of the financial health.
4. Tenure
The duration of NCD investment may range from 12 months to 10 years. The rate of interest on NCD is directly proportional to the holding period. Longer the tenure of a NCD, higher will be its rate of interest. Investors may diversify across NCDs of varying tenures or stick to shorter durations to minimise risks.
5. Interest Payouts
As discussed above, the NCDs offer monthly, quarterly, half-yearly, annually and cumulative interest payout options. Investors can choose the option that suits their income and taxation needs. After being added to the investors' income, interest is completely taxed according to the income slab applicable. TDS will not be deducted if investors hold the debentures in demat form. However, there would be a TDS incidence if the yearly interest surpasses INR 5,000 in any given fiscal year.
6. Liquidity
Although NCDs are theoretically liquid since they are traded on the stock exchange, market conditions may not always provide fair value. Therefore, holding NCDs until maturity can be a more beneficial investment strategy.
7. Safety
The ratings of NCDs offer insight into their risk profile and profitability. Riskier NCDs are rated low and give higher returns. The opposite is true for less risky NCDs. Investors should consult the ratings and make decisions based on their risk appetite.
8. Preferential Treatment
As mentioned earlier, the NCDs are classified into two categories: secured and unsecured. Secured NCD holders have priority over unsecured NCD holders when it comes to claims on the issuer's assets.
NCD vs Bonds: Which One’s Better?
Debentures and bonds are the two main types of debt securities. The key differences between the two are outlined in the table below:
Bonds | Non-Convertible Debentures |
There are two types of bonds: convertible and non-convertible. Convertible bonds can be easily converted into equity shares, while non-convertible bonds cannot. | It is not possible to convert non-convertible debentures into stocks. |
Governments typically utilise it to raise money. | It is mostly used by corporations to raise funds. |
Taxability On Bonds And Non-Convertible Debentures
The two prominent debt securities- bonds and NCDs offer a unique case study when it comes to their taxability. There are similarities as well as differences.
Parameter | Non-Convertible Debentures | Bonds |
Holding period | Since NCDs are listed on the stock exchange, they are regarded as long-term capital gains if held for in excess of or equal to twelve months, and short-term capital gains if maintained for a period of time shorter than twelve months. | Only listed bonds and zero-coupon bonds are considered short-term capital gain if held for 12 months and long-term capital gain for greater than or equal to 12 months. |
Tax-saving | NCDs are taxable | Tax-saving bonds and zero-coupon bonds offer tax-saving opportunities. |
Source: Income Tax India4
Conclusion
Non-convertible debentures provide an excellent opportunity to diversify a portfolio while generating substantial interest. Their monthly or quarterly payout structure makes them an attractive option for passive income generation. However, prudent financial planning is essential to make the best of this investment avenue. Credit rating agencies and financial statements can help investors make prudent decisions.
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Frequently Asked Questions On Types Of Non-Convertible Debentures
1. Is NCD better than FD?
The profitability of any asset depends on the nature of an individual. While the return generated through NCD is much higher compared to FD, fixed deposits are one of the safest investment avenues. The profitability and suitability depend on the risk-taking capacity and goal of investors.
2. What is the interest rate on non-convertible debentures?
The return on NCD is higher than convertible debentures because they are not listed. The higher yield results from the fact that they are not backed by financial assets. However, assets rated AA or higher are often safe to invest. Due diligence is key.
3. Is NCD tax-free?
Long-term capital gains on the sale of an NCD (listed security) are taxed at reduced rates under section 112 of the IT Act, whereas short-term capital gains would be taxed at regular rates.
References
1. SEBI, accessed from: https://www.sebi.gov.in/statistics/corporate-bonds/publicissuedata.html
2. SEBI, accessed from: https://www.sebi.gov.in/sebi_data/commondocs/amend_h.html
3. Crisil, accessed from: https://www.crisilratings.com/en/home/our-business/ratings/credit-ratings-scale.html
4. Income Tax India, accessed from: https://incometaxindia.gov.in/Documents/Left%20Menu/income-from-capital-gains.htm
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