Non-Convertible Debentures 101: A Complete Guide To NCD Investment
NCD investment provides an attractive path for those seeking steady income and portfolio diversification. But what sets NCD (non-convertible debentures) apart from other financial instruments?
With distinct characteristics that shine in the fixed-income avenue, they offer more than just predictable returns. These debt securities present unique advantages that can not be overlooked. Are you curious if they are the right fit for your portfolio? Let us explore non-convertible debenture meaning, their key aspects and find out how they could align with your broader strategy.
What Are Debentures?
Before we explore NCDs, it is important to understand debentures first. The instruments allow organisations to raise capital without giving up ownership like stocks. These instruments are commonly issued by governments for periods exceeding ten years, while businesses use them for long-term financing1.
They provide regular payments to investors, known as coupon payments. The terms, such as the payment schedule and interest rate, are outlined in a contract called an indenture. Companies favour these tools due to their lower costs and extended repayment periods.
There are different types of debentures. One key type is the NCD.
What Are Non-Convertible Debentures ?
As noted earlier, NCDs are a form of debentures issued by corporates to raise funds from investors. The issue of non-convertible debentures comes with fixed terms and fixed interest rates that mature and cannot be converted to equity shares of their issuing company.
Investors who purchase NCDs typically enjoy regular interest payments at a fixed rate over the term of the Debenture. This makes NCDs an appealing investment choice for investors seeking predictable returns.
NCDs are issued both publicly and privately and are rated by credit rating agencies based on the issuer's creditworthiness. These ratings help investors assess risk before making their investment decision.
Convertible debentures allow investors to exchange debt for company shares, providing equity potential. In contrast, non-convertible options focus purely on fixed interest, offering higher returns without equity conversion.
Features Of Non-Convertible Debentures
Here are features of non-convertible debentures you must keep in mind before making your decision:
1. Fixed Interest Rates
Non-convertible debentures interest rates are fixed, making them an effective way of guaranteeing returns from investments over their duration. You will know exactly how much interest will accrue over its lifespan.
2. Fixed Tenure
NCDs come with fixed tenures, meaning you know exactly when you will receive interest payments and when your principal amount will be returned back to you - can be perfect for investors seeking an established investment horizon.
3. No Equity Ownership
In contrast with convertible debentures, which may be exchanged for equity shares of a company at any point in time, NCDs do not confer any equity ownership and consequently do not confer voting rights or ownership stake in the said business.
4. Tradable On Stock Exchanges
NCDs can often be traded on stock exchanges, giving investors easy and flexible investment solutions. Having these securities readily tradable provides both liquidity and flexibility in portfolio planning.
5. Credit Rating
Nearly all NCDs come equipped with a credit rating from an external agency that assesses their issuer company and offers investors an accurate indication of risk and return in each investment opportunity.
Types Of Non-Convertible Debentures
NCDs can be categorised into two main types. Each has distinct qualities, offering varying levels of risk and reward.
1. Secured Non-Convertible Debentures
These are protected by the company’s assets, which act as collateral. If the company defaults, holders of these instruments have a legal claim on the pledged assets. This reduces risk, so the interest rates are generally lower. Investors looking for stability often prefer this option.
2. Unsecured Non-Convertible Debentures
Unlike the secured type, these lack collateral backing. This means there is no asset to fall back on if the company fails to repay. However, they tend to offer higher returns due to the increased risk. Those willing to take on more uncertainty in exchange for better yields may find unsecured debentures appealing.
Choosing between these two depends on your tolerance for risk and your financial objectives.
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. |
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.
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. |
Understanding The Risks Involved With NCDs
1. Credit Risk and Issuer Default
Credit risk is a key factor to consider when investing in NCDs. If the issuer defaults on payments, investors may lose their principal. To mitigate this, choose NCDs from reputable issuers with strong credit ratings. Platforms like Grip Invest provide detailed ratings, helping investors make informed decisions based on an issuer’s financial health.
2. Interest Rate Risk and Market Fluctuations
Interest rate risk is another consideration. Rising rates can decrease the value of existing NCDs, especially those with lower fixed rates. Shorter-duration NCDs are generally more stable during interest rate fluctuations. Investors should stay informed about the interest rate environment to better understand the potential impact on their fixed-income investments.
Which Types of Investors Should Consider NCDs?
1. Conservative Investors Seeking Stability
Conservative investors with low risk tolerance prefer NCDs for their predictable fixed returns and capital preservation. These investments offer security through regular interest payments, making them ideal for retirees or those saving for future expenses. Senior secured NCDs add an extra layer of protection, providing safety while minimizing volatility compared to stocks.
2. Investors Looking for Diversification with Fixed Income
For those seeking portfolio diversification, NCDs offer a solid fixed-income option. Investors with equities or high-risk assets can use NCDs to balance risk, offering stability and steady returns. This makes them a great choice for those looking for a conservative investment in a more dynamic portfolio.
Regulatory Framework And Investor Protection
1. SEBI Guidelines
To protect investors, SEBI has issued guidelines on non-convertible debentures (NCDs), such as disclosure requirements and monitoring issues financials. These regulations detail requirements such as disclosure, credit rating, and monitoring of the issuer's financials.
2. Credit Rating
A key part of investor protection lies with credit ratings. SEBI mandates issuers obtain one from an approved rating agency so as to provide investors with an independent assessment of an issuer's ability to repay NCDs timely.
3. Disclosure Requirements
Issuers must disclose all pertinent details surrounding an NCD offering, such as terms and conditions, credit rating, use of proceeds, and financials - to give investors full access to relevant data before investing. This ensures investors receive accurate advice before purchasing NCDs.
4. Listing on Stock Exchanges
SEBI has mandated that NCDs must be listed on recognised stock exchanges to provide investors with liquidity and transparency, as the prices and trading volumes for NCDs can be seen publicly. This offers investors access to liquidity as their investments become available for public scrutiny.
Now that you have understood what are NCDs and how they offer fixed returns, you must be wondering what difference it has from corporate fixed deposits as they are also safe and offer fixed returns. Let’s understand this with the comparison below:
Corporate Fixed Deposit Vs Non-Convertible Debentures
Feature | Corporate Fixed Deposits (FDs) | Non-Convertible Debentures (NCDs) |
Source | Offered by businesses and financial institutions. | Raised by corporations to gather funds from the public. |
Return Type | Provides a fixed payout, typically higher than regular bank deposits. | Can have fixed or variable rates, influenced by the terms of the offer. |
Exposure | Generally low-risk, but credit risk depends on the financial stability of the issuing entity. | Market-driven, especially sensitive to interest rate changes. Secured ones are safer, while unsecured carry higher uncertainty. |
Market Volatility | Very little connection to market changes. | Can fluctuate with market conditions, affecting pricing and resale value. |
Protection | Not backed by any form of insurance like DICGC- Deposit Insurance and Credit Guarantee Corporation. | Secured variants are backed by assets; however, neither type is insured. |
Liquidity | Cannot be sold in secondary markets, limiting flexibility. | Easily traded on stock exchanges, offering better liquidity options. |
Potential Gains | Typically offers lower yields compared to higher-risk products. | Higher potential earnings, especially for unsecured options, reflecting added risk. |
Conclusion
Non-convertible debentures offer companies reliable long-term capital without conversion options into equity shares. While they do not feature interest rate guarantees or maturity dates like convertible debentures do.
Overall, non-convertibles make an essential financial tool used both by companies as well as investors - potentially creating an advantageous situation all around for all involved!
If you desire to make an investment in NCDs (Corporate Bonds), sign up on Grip Invest now and explore corporate bonds!
Reference
1. The Economic Times, Accessed from: (https://economictimes.indiatimes.com/definition/debenture)
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Disclaimer: This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip Invest Technologies Private Limited ("Grip", formerly known as Grip Invest Advisors Private Limited) is not registered with SEBI in any capacity and does not advise, encourage, or discourage its users to invest or not invest in any securities. Grip is solely an execution-only platform and does not guarantee or assure any return on investments made by you in any opportunities sourced by Grip and accepts no liability for consequences of any actions taken based on the information provided. Your investment is solely based on your judgement. Investments in debt securities are subject to risks. Read all the offer-related documents carefully.
