Non-Convertible Debentures (NCDs): Meaning, Features, Interest rate

Non-Convertible Debentures (NCDs):

Non-Convertible Debentures (NCDs) are financial instruments issued by companies to raise long-term funds from investors. These debentures are a form of debt, and unlike convertible debentures, they do not provide the option to convert them into equity shares. This makes NCDs a fixed-income investment, offering stable returns over a specific period.
Since NCDs are not secured by collateral, they heavily rely on the creditworthiness and reputation of the issuing company. Typically, large corporations with a strong financial background issue NCDs, attracting investors with a fixed interest rate without any security backing.

Types of Debentures:

There are two main types of debentures:

Convertible Debentures: These debentures provide holders with the option to convert them into shares of the issuing company after a specified period.
Non-Convertible Debentures (NCDs): NCDs, as the name suggests, do not offer any conversion option. At maturity, investors only receive their principal amount along with interest.

What are Non-Convertible Debentures?

Non-Convertible Debentures are fixed-income securities with predetermined terms and interest rates. Companies issue NCDs to raise capital without giving investors the option to convert them into shares. They are popular among investors seeking steady returns without the volatility of the stock market.
NCDs are not backed by any physical assets or collateral. Therefore, the credit rating of the issuing company becomes critical. Credit rating agencies regularly assess the creditworthiness of the issuer, which helps investors gauge the risk involved.

Types of Non-Convertible Debentures

There are two main types of NCDs:

Secured NCDs: These are backed by the issuer’s assets, offering greater security to investors. In the event of default, investors can claim the company's assets.
Unsecured NCDs: These are not backed by assets and rely solely on the company’s ability to repay. Since they carry a higher risk, unsecured NCDs typically offer higher interest rates.

Key Features of Non-Convertible Debentures:

Issuance Process: NCDs are usually offered through public issues, where investors can subscribe to them within a specific time frame.
Tradable Securities: Once issued, NCDs are listed on the stock exchange, making them tradable like shares or bonds. This provides liquidity to investors.
Credit Rating: NCDs are not backed by any collateral, so only companies with good credit ratings can issue them. Credit rating agencies assess the issuer's financial health, providing transparency to potential investors.
Fixed Interest Rates: The interest rates on NCDs are usually fixed. The interest rate is inversely related to the company's credit rating. Companies with higher credit ratings typically offer lower interest rates, while lower-rated companies offer higher rates to attract investors.
Return Opportunities: Investors can earn returns through fixed interest payments. Some NCDs may also offer cumulative returns, where interest is compounded over time.

Non-Convertible Debentures Interest rate:

The interest rate of a Non-Convertible Debenture (NCD) is influenced by its maturity period and the frequency of interest payments:

Short-Term NCDs (24 months): Typically have an annual interest rate of around 9.25%.
Medium-Term NCDs (36 months): Offer interest rates ranging from 9.32% to 9.65%.
Long-Term NCDs (60 months): Generally have interest rates between 9.56% and 9.90%.

NCDs usually feature a fixed interest rate ranging from 7% to 9% if held until maturity. Furthermore, unsecured NCDs typically offer higher interest rates than secured NCDs.

NCDs provide various interest payment options, including:

Monthly
Quarterly
Half-yearly
Annually

Additionally, there is a cumulative payout option available for investors.

Tax Implications of NCDs:

NCDs are subject to taxation when sold:

Short-Term Capital Gains (STCG): If the NCD is sold within one year of purchase, it is subject to STCG tax.
Long-Term Capital Gains (LTCG): If sold after one year or before maturity, the NCD is subject to LTCG tax at 20% with indexation benefits.

How to Purchase NCDs:

To invest in NCDs, investors can participate in the public issue during the subscription period. After the NCDs are listed on the stock exchange, investors can buy and sell them through registered stockbrokers or other trading platforms.

Factors to Consider Before Investing in NCDs:

Credit Rating: Since NCDs are not backed by collateral, the company's ability to repay the debt is critical. It's advisable to invest in companies with a credit rating of AA or higher to minimize risk.
Debt Levels: Review the financial statements of the issuer to assess their debt-equity ratio and overall financial health. A company with high debt may struggle to meet its repayment obligations.
Capital Adequacy Ratio (CAR): This ratio measures the company’s ability to absorb potential losses. A higher CAR indicates that the company is better positioned to withstand financial challenges.
Non-Performing Assets: Check whether the company regularly provisions for non-performing assets (NPAs). This shows whether the company is capable of managing its bad debts and maintaining profitability.
Interest Coverage Ratio: This ratio indicates how many times a company can cover its interest payments from its earnings. A higher interest coverage ratio suggests the company is better equipped to meet its interest obligations.

Benefits of Investing in NCDs:

Steady Income: NCDs provide fixed interest payments, making them a reliable source of regular income for investors.
Low Risk (for Secured NCDs): Secured NCDs offer lower risk compared to unsecured ones, as they are backed by the company's assets.
Liquidity: Since NCDs are traded on the stock exchange, they offer liquidity, allowing investors to sell them before maturity if needed.

Risks of Investing in NCDs:

Credit Risk: The biggest risk with NCDs is the issuer’s creditworthiness. If the company faces financial difficulties, it may default on its payments.
Interest Rate Risk: NCDs are sensitive to changes in interest rates. If market interest rates rise, the value of the NCD may fall, affecting returns for investors.

Conclusion:

Non-Convertible Debentures are a useful investment tool for those seeking fixed returns over a specific period. However, as these instruments are not secured by collateral, it is essential to assess the financial health and credit rating of the issuer before investing. By thoroughly evaluating the company’s creditworthiness, debt levels, and interest coverage ratio, investors can minimize their risk and ensure steady returns.
In summary, NCDs offer a stable and relatively safe investment option, especially for those who prefer predictable returns over the uncertainty of equity investments. However, it is crucial to do proper research and consider factors like credit ratings, capital adequacy, and debt levels to make an informed decision.

FAQs:

Is it good to invest in NCD?

NCDs are debt instruments commonly used by NBFCs and companies to raise long-term capital through public issues. They offer better returns, liquidity, lower risk, and tax benefits compared to convertible debentures.

What is meant by NCD?

Non-convertible debentures (NCDs) are fixed-income debt instruments issued by high-rated companies through public offerings to raise long-term capital. Unlike convertible debentures, NCDs cannot be converted into equity or stocks.

Is NCD better than FD?

NCDs offer higher interest rates compared to Fixed Deposits (FDs), making them more attractive for investors. FD interest rates are generally lower, and the interest earned is taxed as per the investor's tax slab. Additionally, investors can trade in NCDs if they are listed on the stock exchange, providing liquidity.

Is NCD tax free?

Tax implications apply to NCDs, requiring capital gains tax on the interest earned. However, NCDs held in Demat form are exempt from TDS. In contrast, bank FDs are insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to Rs. 1 lakh.

What is the disadvantage of NCD?

If your NCD investment isn't listed, selling it before maturity can be challenging, which may limit liquidity and make it difficult to access your funds early. Additionally, since NCDs generally offer fixed interest rates, they are sensitive to fluctuations in interest rates, potentially affecting their market value.

Who is eligible for NCD?

Public Financial Institutions, Statutory Corporations, Commercial Banks, Co-operative Banks, and Regional Rural Banks are authorized to invest in NCDs. Additionally, Provident Funds, Pension Funds, Superannuation Funds, and Gratuity Funds are also permitted to invest in NCDs.

Can I sell an NCD before maturity?

NCDs cannot be redeemed or withdrawn before maturity; however, they can be sold on the secondary market to allow for an early exit.

What happens after maturity of NCD?

When you hold NCDs until maturity, the issuer repays the principal amount along with the interest (in the case of cumulative NCDs).

How to calculate NCD return?

For example, if you buy a Rs. 1,000 bond with an 8% stated interest rate at Rs. 1,100, your current yield would be calculated as follows:
Current Yield= Annual Interest Payment / Current Market Price = Rs.1,000×0.08 / Rs.1,100
So, the current yield is approximately 7.27%.

What is the interest rate of NCD?

The interest rate of NCDs is influenced by the credit rating of the issuer and prevailing market conditions. Typically, these interest rates range from 7% to 9% per annum.

What is the validity of NCD?

Most insurers allow you to retain your No Claim Discount (NCD) for up to 2 years (and sometimes 1 year) after selling your old car before it resets to 0%. For instance, if you had a 50% NCD when you sold your car and purchased a new one within 2 years, you would keep your 50% NCD entitlement. However, if you wait more than 2 years, your NCD will reset to 0%.

We hope that you like this content and for more such content Please follow us on our social site and YouTube and subscribe to our website.

Manage your business cash flows and payable/receivables using our Bahi Khata App

Download Bahi Khata