What is Non-Convertible Debentures(NCDs) in India? Know its Features & Types

Non-convertible debentures are debentures in which the option for conversion of debentures to equity, at a later date, is not there. NCDs, or non-convertible debentures (NCDs),are popular investment products among those who are seeking stable and fixed returns. In contrast to secured instruments, most NCDs are unsecured. They are common instruments used by established companies to raise long-term capital at fixed interest rates.

While debentures come in various forms, convertible and non-convertible debentures are the most popular. Convertible debentures allow conversion into equities, whereas NCDs provide fixed returns without a conversion option.

What is Non Convertible Debentures

Non convertible debentures meaning refers to fixed-income instruments issued by companies that cannot be converted into equity shares. They offer regular interest payouts and are typically used to raise long-term capital. NCDs are ideal for investors seeking stable returns without ownership in the company.

Non Convertible Debentures Example: Suppose ABC Ltd. issues NCDs worth ₹1,000 each with a coupon rate of 9% per annum for a tenure of 5 years. These debentures cannot be converted into equity shares and will mature at the end of 5 years, paying back the principal along with periodic interest (usually annually or semi-annually).

Such NCDs may also be listed on stock exchanges, allowing investors to buy/sell them in the secondary market.

Features of Non-Convertible Debentures

Non-Convertible Debentures (NCDs) offer fixed returns and are a popular investment option for conservative investors. They cannot be converted into equity shares.

1. Fixed Interest Rate: Provides predictable income throughout the tenure.
2. Non-Convertible Nature: Cannot be converted into company equity.
3. Listed on Exchanges: Enables trading in the secondary market.
4. Credit Rating: Rated to assess risk and reliability.
5. Secured or Unsecured: May be backed by assets or not.
6. Defined Tenure: Comes with a fixed maturity period.
7. Taxable Returns: Interest is taxable based on income slab.

How Non-Convertible Debentures (NCD) Work?

Non-Convertible Debentures (NCDs) work like loans taken by companies from investors.

1. Issuance: A company issues NCDs to raise funds from the public for a fixed tenure.
2. Interest: Investors earn a fixed interest (coupon rate) regularly monthly, quarterly, or annually.
3. Maturity: At the end of the tenure, the company repays the principal amount to the investor.
4. Non-convertibility: These debentures cannot be converted into equity shares, unlike convertible debentures.
5. Rating: NCDs are credit-rated by agencies, helping investors assess the risk level.

They are popular among conservative investors seeking predictable income with lower risk than equities.

Types of Non-Convertible Debentures

The following are the two most important types of non-convertible debentures:

1. Secured NCDs

Secured non-convertible debentures are debentures that are covered by particular assets which the issuer promises to use as collateral. Usually when a debenture is secured, the more appropriate term for it is bond. NCDs are the name for unsecured bonds. In case of a default, debenture holders can claim and liquidate those assets to recover their investment. Secured debentures are more uncommon compared to unsecured debentures and safer investments.

2. Unsecured NCDs

Unsecured non-convertible debentures are not secured by any asset or collateral. The only thing backing them is the creditworthiness and financial soundness of the issuing company. Companies offer unsecured NCDs with higher interest rates to appeal to investors, compensating for the higher degree of risk due to the lack of security.

Who Can Invest in Non-Convertible Debentures (NCDs)?

Non-convertible debentures (NCDs) are open for subscription by non-institutional investors, institutional investors, and individuals, with specific categories as follows:

1. Category I (Institutional Category)

This category includes:

• Banks (cooperative, regional, rural, and commercial)
• Mutual funds
• Pension funds
• Venture capital and Alternate Investment Funds (AIF)
• Statutory corporations and public financial institutions
• Insurance companies
• National investment funds
• Foreign portfolio investors

2. Category II: Non-Institutional Investors

This category includes:

• Trusts (private, public, and charitable) (if authorised)
• High net-worth and ultra-high-net-worth individuals
• Corporations, including body corporates and cooperative societies
• LLP and partnership firms
• Scientific and research institutions (if authorised)

3. Category III (Individual Category)

This category includes:

• Resident Indians
• Non-Resident Indians (NRIs)
• Hindu Undivided Families (HUFs) via the Karta

4. Exclusions for Investing in Non-Convertible Debentures

Here are all the individuals and entities who cannot invest in NCDs:

• Individuals under 18 years of age cannot invest.
• NRI, foreign nationals, or persons of foreign origin can only invest if the issuer has received specific regulatory approval.
• Individuals deemed unfit by regulatory authorities are also ineligible.
• Foreign institutional investors, qualified portfolio investors, foreign portfolio investors and overseas corporate bodies cannot apply for NCDs.

How to Purchase NCDs?

NCDs , that are not privately placed, are first issued through public offerings and later traded on stock exchanges like BSE and NSE. You can either subscribe during the initial issue or buy them from the secondary market.

When investing in NCDs, it is essential to analyse the credit rating, coupon rate, and financial position of the issuer. Well-rated NCDs, for instance, AAA, have more security and would give better returns. Further, scan through the company’s financial statements to know the profitability and loan repayment history of the company.

After the SEBI approves the prospectus of the company, the companies issue NCDs in a public offering open for a specified period, just like an IPO.

To buy non-convertible debentures available in market online, follow these steps:

• Step 1: Ensure you have an active demat and trading account with a registered stockbroker.
• Step 2: Log in to your online stockbroking account.
• Step 3: Place a buy order for the NCD during the subscription period.
• Step 4: Make sure that you have sufficient funds in your account to cover the investment amount.

What Are the Benefits of Investing in Non-Convertible Debentures?

There are numerous advantages to investing in non-convertible debt securities, which provide a source of fixed income and diversification to investors. Some of the main benefits include:

• High Credit Rated NCDs and Low Risk: Companies that issue NCDs are usually highly rated and have low risks of defaulting on payment. If an investor goes for secured NCDs, there is more capital protection than an unsecured debenture.
• Fixed Returns: NCDs give investors fixed interest returns, ensuring predictable income during the entire period of investment. This feature makes them ideal for people who are keen on stable cash flows.
• Diversification: By investing in NCDs issued by various companies in different sectors, an investor can diversify his or her portfolio. Diversification is a strategy that reduces risks of non-convertible debentures from market fluctuations and sector-specific downturns.
• Higher Returns: NCDs generally offer higher interest rates compared to traditional fixed-income instruments like bank fixed deposits (FDs). This makes them appealing to investors looking for better yields on their investments without taking on high risks.
• Tax Benefits: The interest generated from NCDs is taxed at an investor’s applicable tax slab rates, which is beneficial for investors at lower tax brackets. Moreover, only a 10% TDS is applicable to the interest generated. For people with incomes lower than the taxable limit, NCDs are tax-efficient investments.
• Liquidity: Publicly listed NCDs are traded on the stock exchanges, and hence the investor can access liquidity before the maturity date. Investors can easily buy or sell these securities in the secondary market, and thus, an exit route is available if needed.
• Credit Ratings: Credit rating agencies rate companies that issue NCDs, which assess the creditworthiness of the issuer. This information allows investors to make informed decisions and manage their credit risk effectively.
• Flexible Tenure Options: Non-convertible debentures are available in different tenures, ranging from short-term to long-term, which gives investors the opportunity to choose a tenure that suits their financial goals and risk profiles.

Risks of Non-Convertible Debentures (NCDs)

Investing in NCDs carries risks like credit default and liquidity issues. Market interest rate changes can also impact their value and returns.

1. Credit Risk: If the issuing company defaults, investors may lose interest or principal.
2. Liquidity Risk: NCDs may not be easily tradable in the market, making exits difficult.
3. Interest Rate Risk: Rising interest rates can reduce the market value of fixed-rate NCDs.
4. Company Performance Risk: Poor financial health of the issuer can affect returns.
5. No Equity Upside: Unlike convertible debentures, NCDs don’t offer potential stock appreciation.

How Does NCD Taxation Work?

While there is no tax on the purchase of non-convertible debentures (NCDs), the sale and interest income from NCDs are subject to taxation.

• Tax on Sale of NCDs Within One Year: If the NCDs are sold in the secondary market within a year from their date of purchase, then it is considered under Short Term Capital Gains and taxed at a tax rate of 20%.
• Tax on Sale of NCDs After One Year but Before Maturity: In case the NCDs are sold more than a year before their maturity, the Long-Term Capital Gains Tax will be a flat 12.5%.
• Tax on Interest Income: Interest generated through NCDs that are held till maturity is considered ‘income from other sources’. Their taxation is based on the investor’s income tax slab.

Difference Between Fixed Deposits and Non-Convertible Debentures (NCDs)

While both offer fixed returns, NCDs generally provide higher interest but come with higher risk compared to the safety of traditional fixed deposits.

Things an Investor Should Consider Before Investing in NCDs

Non-convertible debentures for beginners carry various business and financial risks, and investors should evaluate many factors before investing. Here are some important aspects to look at

1. Credit Rating: Check the rating by agencies like CRISIL or ICRA to assess default risk.
2. Issuer’s Financial Health: Evaluate the company’s past performance and stability.
3. Interest Rate: Compare the coupon rate with other fixed-income options.
4. Tenure & Lock-In: Understand the maturity period and any early exit restrictions.
5. Liquidity: Confirm if the NCD is listed on exchanges for ease of selling.
6. Tax Implications: Interest earned is taxable as per the investor’s slab.
7. Type of NCD: Know whether it’s secured or unsecured, affecting safety and risk.

Conclusion

Typically, organisations raise funds through non-convertible debentures to achieve specific business objectives. Investors should know the objective of raising the funds and what the company intends to do with it.

Interest rates are an important consideration, but they do not entirely decide the returns you will get. You must judge the investment on a larger scale by checking metrics such as current yield and yield to maturity (YTM). Also, check whether it will be able to pay back the NCDs and its investors at the time of maturity.

Proper due diligence over the company’s stability and credibility will give an even better understanding of the investment.