Companies have two main ways to get money: by selling parts of the company (shares) or by taking loans (debentures). When companies want to borrow without giving away ownership, they often choose debentures.
Big companies usually use debentures to get money. Unlike some debentures that can be turned into ownership (convertible debentures), non-convertible debentures stay as loans—they can’t be turned into ownership.
Even though you don’t become an owner, non-convertible debentures are a good way to invest because they give you fixed returns and come with unique features
In this article, we will go in deep about Non-Convertible Debentures, their features, types and points to keep in mind while investing in NCDs.
What are Non-Convertible Debentures (NCDs)?
Non-Convertible Debentures (NCDs) are like loans that you, as an individual, give to a company. Imagine you lend money to a friend, and they promise to pay you back with some extra money as interest after a certain period. In the business world, companies do something similar through NCDs.
When a company needs money for various reasons like expanding their business or funding projects, they issue NCDs. These are like IOUs that the company sells to people, who in turn become creditors.
Unlike some loans, NCDs don’t let you convert your loan into ownership (like getting equity shares of the company). Instead, you’re a lender, and the company promises to return your money with interest on a set date in the future.
The interest you receive is the incentive for lending your money. NCDs can be appealing because they often offer higher interest rates than regular savings accounts. However, like any investment, there are risks involved, such as the company facing financial trouble and not being able to pay back the borrowed money.
So, it’s a bit like helping out a friend financially, but in this case, it’s a business deal between you and a company.
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Why do companies issue NCDs?
Companies use Non-Convertible Debentures as a smart financial move to get the money they need. Instead of just going to the bank or selling parts of the company, they use NCDs to mix things up.
It’s like a special way of borrowing money from regular people who, in return, get extra money back as a thank-you (interest). This helps companies have different sources of money and not rely too much on just one.
NCDs offer stability because they lock in a fixed interest rate for a long time, and this is appealing to people who want to invest because they can get better returns compared to regular savings. Companies benefit by attracting money from different people, and they decide to do this when the market conditions are good for it.
So, NCDs are a way for companies to get long-term money and for people to make more from their investments.
Features of NCDs
NCDs have following features compared to other investment avenues,
- Non-Convertible Nature:
- Non-Convertible Debentures cannot be converted into equity shares. Investors don’t have the option to exchange their debentures for ownership in the company. Instead, they receive fixed interest payments and the principal amount at maturity, providing a predictable income stream.
- Fixed Interest Rates:
- NCDs offer a fixed interest rate, providing investors with clarity on their returns. This fixed-rate feature makes NCDs attractive to those seeking stable and predictable income over the debenture’s term.
- Maturity Period:
- NCDs have a defined maturity period, indicating when the principal amount will be repaid to investors. This feature allows investors to plan and manage their investment horizon, aligning with their financial goals.
- Credit Ratings:
- NCDs are assigned credit ratings by agencies, indicating the issuer’s creditworthiness. Higher-rated NCDs imply lower credit risk. Investors can use these ratings to assess the safety of their investment, considering the likelihood of timely interest payments and repayment of principal.
NCDs are an appealing investment option for those seeking a fixed-income instrument with a known maturity date, predictable returns, and a certain level of risk, as indicated by credit ratings.
Types of Non-Convertible Debentures: Secured and Unsecured
There are two main types of NCDs namely, Secured and Un-secured NCDs.
Secured NCDs:
Secured Non-Convertible Debentures are backed by specific assets or a charge on the company’s assets. This means that if the issuing company fails to meet its payment obligations, the debenture holders with secured NCDs have a claim on the specified assets.
The company pledges assets as collateral, providing an additional layer of safety for investors. In case of liquidation or bankruptcy, secured debenture holders have priority in receiving repayments from the sale of the specified assets.
As a result, secured NCDs are generally considered less risky compared to their unsecured counterparts.
Unsecured NCDs:
Unsecured Non-Convertible Debentures, also known as naked debentures, lack specific collateral backing. Unlike secured NCDs, these debentures do not have a claim on specific assets of the company.
In the event of default, holders of unsecured NCDs have a claim on the company’s general assets only after the secured debenture holders have been compensated.
Unsecured NCDs typically carry higher risk compared to secured ones, reflecting the absence of dedicated collateral. Investors in unsecured NCDs rely on the overall creditworthiness of the issuing company.
Consequently, these debentures may offer higher interest rates to compensate for the increased risk associated with their unsecured nature.
To summarize:
| Feature | Secured NCDs | Unsecured NCDs |
|---|---|---|
| Collateral | Backed by specific assets or a charge on the company’s assets. | Lack specific collateral; not backed by dedicated assets. |
| Risk Level | Lower risk due to asset backing. | Higher risk as there is no dedicated collateral. |
| Priority in Repayment | Higher priority in case of default; secured debenture holders are compensated first from the sale of specified assets. | Lower priority; unsecured debenture holders are compensated after secured debenture holders. |
| Interest Rates | Generally lower interest rates compared to unsecured NCDs due to lower risk. | May offer higher interest rates to compensate for the increased risk associated with the absence of collateral. |
| Investor Appeal | Attractive to conservative investors seeking lower-risk fixed-income investments. | Appeals to investors willing to take on more risk in exchange for potentially higher returns. |
How to Purchase Non-Convertible Debentures?
NCDs can be purchased at two different time period.
- Purchasing from the issuer during the issue period
- Purchasing from secondary markets after listing
Non-Convertible Debentures are accessible for purchase from the issuing company during the specified NCD issue period. Investors can engage in this process through a broker or directly via the stock exchange where the NCDs are listed.
To invest, individuals need to complete the application process, specifying details such as the desired NCD series and investment amount. Crucially, compliance with Know Your Customer (KYC) requirements is mandatory, involving the submission of identity and address proofs.
Following the closure of the NCD issue period, the issuing company conducts an allotment process. Successful allotments result in the credited NCDs to the investor’s Demat account, ensuring secure electronic holding.
Additionally, investors can trade NCDs on the secondary market, providing an avenue for buying or selling similar to the stock market.
This secondary market activity enhances liquidity and flexibility for investors, allowing them to manage their NCD holdings based on market conditions and investment goals.
Regular monitoring of interest payments, maturity dates, and market dynamics is crucial for investors looking to optimize their NCD investments and make informed decisions.
Who Can Invest in Non-Convertible Debentures?
NCDs are open to a wide range of investors, and eligibility criteria may vary based on the issuing company’s terms and regulatory guidelines.
Generally, the following types of investors can consider investing in NCDs:
- Individuals:
- Retail investors, including individuals, can invest in NCDs. They can apply for NCDs during the issue period through brokers or other authorized channels.
- Hindu Undivided Families (HUFs):
- HUFs are considered eligible investors and can participate in NCD offerings.
- Companies and Corporate Bodies:
- Companies, both private and public, are often eligible to invest in NCDs. Corporate bodies, trusts, and other legal entities may also be allowed to invest, subject to regulatory guidelines.
- Financial Institutions:
- Banks, financial institutions, and other entities in the financial sector may invest in NCDs as part of their investment portfolio.
- Non-Resident Indians (NRIs):
- NRIs are generally allowed to invest in NCDs, subject to certain conditions and regulatory approval. The terms may vary depending on the issuing company and regulatory guidelines.
- Qualified Institutional Buyers (QIBs):
- Institutional investors such as mutual funds, insurance companies, pension funds, and other qualified institutional buyers can participate in NCD issuances. They often invest in large quantities.
- Foreign Institutional Investors (FIIs):
- In some cases, FIIs may be permitted to invest in NCDs, subject to regulatory limits and guidelines.
Factors to Consider Before Investing
Credit Rating of the Issuer:
Credit rating is an evaluation provided by credit rating agencies (such as CRISIL, ICRA, or CARE) assessing the creditworthiness of the issuing company. Ratings range from AAA (highest) to D (default). Higher ratings suggest a lower risk of default, indicating a more financially stable and creditworthy issuer.
Investors should prioritize NCDs from issuers with higher credit ratings, as they imply a lower risk of default. It’s essential to align the credit rating with one’s risk tolerance and investment objectives.
Interest Rate:
The interest rate, also known as the coupon rate, is the fixed rate of interest that the issuing company agrees to pay to debenture holders at regular intervals. It determines the income earned by investors from the NCD investment.
Higher interest rates may attract investors, but it’s crucial to assess whether the offered rate is competitive compared to prevailing market conditions and other fixed-income alternatives.
Tenure :
Tenure refers to the duration for which the NCDs are issued and is the period until maturity. It indicates how long the investor’s money will be tied up in the investment.
Investors should align the tenure of NCDs with their financial goals and liquidity needs. Longer tenures may offer higher interest rates but can limit liquidity.
Redemption Terms:
Redemption terms outline how and when the issuing company will repay the principal amount to investors. NCDs can be redeemed at maturity, or in the case of callable NCDs, the issuer may have the option to redeem them before maturity.
Understanding redemption terms is crucial for planning cash flows. Callable NCDs introduce the possibility of early redemption, which may impact investors’ expected returns.
Issuer’s Financial Position:
This factor assesses the financial health and stability of the issuing company. Key financial indicators include revenue growth, profitability, debt levels, and overall financial management practices.
Investors should analyze the financial position of the issuing company to gauge its ability to fulfill interest payments and repay the principal at maturity. Companies with a robust financial position are considered more reliable.
Also Read: What is Draft Red Herring Prospectus (DHRP) and DHRP Vs RHP
Difference between Corporate FDs and NCDs
Corporate Fixed Deposits (FDs) and Non-Convertible Debentures (NCDs) are different ways companies borrow money. Think of Corporate FDs like a company’s version of your fixed deposit at a bank. They offer a fixed interest rate for a set time, and if the company is well-known, it’s considered safer.
On the other hand, NCDs are like loans you give to a company in exchange for regular interest payments. They are a bit riskier, and some NCDs may even allow you to turn your loan into a share of the company.
Corporate FDs are simple, not traded, and you keep them until they mature. NCDs, however, can be traded on the stock market like shares, giving you the option to sell them if you need money.
The risk with FDs is mostly about whether the company will be able to pay you back. For NCDs, it’s a bit more complicated, as agencies give them ratings to tell you how safe or risky they are.
Remember, FDs are generally straightforward and safer, while NCDs offer more options but come with a bit more risk.
Conclusion
Wrapping up, NCDs offer a simple way for regular folks to loan money to big companies. It’s like a friendly deal where you give them some money, and they promise to pay it back with a little extra after a while – think of it like a fixed bonus. The cool part is, you don’t become a part-owner of the company; you’re just being a helpful supporter.
NCDs can have a safety feature. If the company hits a rough patch, they assure us by using their assets to make sure they can still pay us back. Picture NCDs like collectible cards; if you need cash early, you can sell them to someone else.
Keep an eye on the ratings from agencies. A+ is super safe, but lower grades might mean the company could have some difficulty repaying. So, NCDs allow you to back businesses, earn a reliable bonus, and even sell your lending agreement if you feel like it.
It’s a straightforward way for regular folks to assist companies and earn a little extra money along the way.
Frequently Asked Questions About Non-Convertible Debentures (NCDs)
Q1. What are Non-Convertible Debentures (NCDs)?
Answer: Non-Convertible Debentures (NCDs) are a type of fixed-income investment where individuals lend money to companies for a fixed period, earning interest in return. Unlike convertible debentures, NCDs do not offer the option to convert into equity shares.
Q2. How do NCDs work?
Answer: Companies issue NCDs to raise funds. Investors, by buying NCDs, lend money to the company for a specified time. In return, they receive fixed interest payments and get their principal back at maturity.
Q3. What is the difference between Secured and Unsecured NCDs?
Answer: Secured NCDs are backed by the issuer’s assets, reducing risk. Unsecured NCDs, on the other hand, depend solely on the issuer’s creditworthiness, carrying higher risk but offering potentially higher returns.
Q4. How can I purchase NCDs?
Answer: NCDs are usually purchased during their issue period directly from the issuer or on the secondary market through brokers. You can invest through registered brokers or stock exchanges.
Q5. What factors should I consider before investing in NCDs?
Answer: Consider the issuer’s credit rating, debt level, capital adequacy ratio, provisions for non-performing assets, and interest coverage ratio. Ensure you understand the risks associated with the company and its business.
Q6. Can I sell NCDs before maturity?
Answer: Yes, NCDs can be sold on the secondary market before maturity. However, their resale value depends on market conditions and investor demand.
Q7. Are NCDs taxable?
Answer: Yes, the interest earned from NCDs is subject to taxation as per the investor’s income tax slab. Additionally, capital gains tax may apply if NCDs are sold before maturity.
Q8. Who can invest in NCDs?
Answer: Institutional investors, non-institutional investors, and individuals, including resident Indians, Hindu Undivided Families (HUFs), and Non-Resident Indians (NRIs), can invest in NCDs.
Q9. What are the benefits of investing in NCDs?
Answer: NCDs offer fixed returns, diversification, higher returns compared to traditional fixed deposits, tax benefits, liquidity, credit ratings for risk assessment, and flexibility in tenure.
Q10. Should I seek professional advice before investing in NCDs?
Answer: It is advisable to consult with financial professionals or advisors to better understand your risk tolerance, investment goals, and the specifics of the NCDs you are considering.
Q11. What is the role of RBI in NCDs?
Answer: The Reserve Bank of India (RBI) holds a pivotal role in the NCDs, guiding regulations for transparent issuance. It ensures investor protection, setting guidelines on credit ratings and maturity periods. RBI’s monetary policies indirectly influence NCD appeal, impacting interest rates and shaping the dynamics of India’s debt market.
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