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by 5paisa Research Team Last Updated: 2023-05-15T15:35:04+05:30
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Non-Convertible Debentures (NCD) have emerged as one of the most sought-after investment options for individuals who want to earn a fixed rate of return on their investments. 
These are generally not backed by any collateral. Hence, debentures rely mainly on the financial standing and reputation of the issuer. Companies use debentures to raise long-term capital from investors. Well-established companies use these financial instruments to raise funds at a fixed interest rate.

While there are many debentures types, the most common ones are convertible and non-convertible. Convertible debentures allow the holder to convert the debenture into equity shares of the issuing company after a prefixed period. Contrarily, non-convertible debentures do not provide a conversion to option to the holder at maturity.

This article explores Non-Convertible debentures' advantages and disadvantages,  features and the factors to consider before investing. 
 

What are Non-Convertible Debentures (NCD)?

Non-Convertible debentures are long-term debt instruments issued by companies that carry a fixed interest rate for the investment tenor. The issuer redeems these at maturity and is not eligible for conversion into equity shares at maturity. Typically, NCDs are less risky than equity investments since they provide a fixed rate of return.

NCDs benefit investors with increased returns, low risk, liquidity, and tax benefits. Some Non-Convertible Debentures in India also offer additional benefits, such as a higher interest rate for senior citizens or those who apply during the initial subscription period.

Some NCDs also trade in the secondary market. An investor can purchase it from a non-convertible debenture holder without interacting with the issuer. Similarly, the holder can liquidate the investment before maturity in the secondary market. 
 

How Non-Convertible Debentures (NCD) work?

Companies issue NCDs to raise funds for expansion, working capital requirements, and debt refinancing. Individuals who buy these debentures lend money to the company and earn a fixed interest rate on their investment. NCDs are similar to a fixed deposit in a bank, although it trades on stock exchanges. 

The Non-convertible Debentures interest rate is higher than on FDs, making them an attractive investment option. The interest can be paid monthly, quarterly, annually, or cumulative and on principal maturity amount.

Features of NCDs

Non-Convertible Debentures India has various features.

1.    Taxation

NCDs are subject to taxation under the Income Tax Act 1961. The interest earned is taxable per the investor's tax slab. The post-tax returns on these debentures are higher than those on fixed deposits, making them an attractive investment option. 

Selling non-convertible debentures in the secondary market attracts capital gain tax. If you sell them within a year of purchase, the short-term capital gain tax will be applicable as per the income tax slab rate. But, for NCDs sold after a year from purchase and before maturity, the long-term capital gain tax will be applicable at 20% with indexation.

The table below illustrates the post-tax returns on NCDs.
 

Interest from NCD

Post-tax return @10.4%

Post-tax return @20.8%

Post-tax return @ 31.2%

8%

7.17%

6.08%

4.98%

9%

8.06%

6.89%

5.72%

10%

8.95%

7.70%

6.46%

11%

9.84%

8.51%

7.21%

 

2.    Credit rating

Agencies like CRISIL, ICRA, and CARE rate NCDs. Credit ratings are independent agencies that evaluate the creditworthiness of the company and the likelihood of default. NCDs with higher credit ratings are considered less risky and provide a lower rate of return. In contrast, those with lower credit ratings are considered riskier and provide a higher rate of return.

3.    Interest

he credit rating and prevailing market conditions impact the interest rate of the NCDs. Typically, the interest rate ranges from seven to nine percentage points per annum. 

Types of Non-Convertible Debentures: Secured and Unsecured

There are two types of non-convertible debentures - secured and unsecured. 

1.    Secured NCDs

Company assets are collateral for secured NCDs, and the risk is relatively lower. Consequently, interest rates on secured NCDs also tend to be lower. 

2.    Non-Secured NCDs  

Non-secured non-convertible debentures do not have any underlying collateral. Hence, it tends to be high-risk and offers attractive interest rates. Usually, companies with strong creditworthiness issue non-secured NCDs. 

Features of Non-Convertible Debentures (NCDs):

1.    Fixed Interest Rate

NCDs offer a fixed interest rate throughout the instrument's tenure. Compared to traditional fixed deposits, Non-Convertible debentures' interest rate usually returns higher to investors and thus can beat inflation. These debentures provide consistent and timely cash inflows. The price risk is zero if an investor holds the NCD until maturity. 
    
2.    Long Tenure

NCDs usually have a longer tenure than traditional fixed deposits, ranging from a few months to several years. The tenure can also be between two to twenty years without any option of premature withdrawal. It provides long-term capital to the issuer and inculcates a saving habit in investors. 

3.    Secondary Markets

While non-convertible debentures do not offer an option of premature redemption, they can be bought and sold on the stock exchange, providing liquidity to investors. The secondary market for NCDs is less mature than the stock market. However, it is useful in case of an emergency. 

NCDs can benefit from capital appreciation due to price fluctuations in the secondary market. If the interest rate in the market decreases, the price increases. 

4.    Flexibility

Non-Convertible debentures provide flexibility to its investors for interest payout. The investor can choose the interest frequency and plan for cashflows. One can opt for monthly, quarterly, semi-annual, annual or cumulative payments. 

5.    Issuers' Creditworthiness

Certified and professional credit rating agencies assign ratings to NCDs, helping the investors independently assess the issuer's creditworthiness. The risk and reward from NCDs are proportional as the interest rates are lower for NCDs with better ratings. 

Lastly, in case of liquidation, the company prioritises payment to convertible debenture holders over equity shareholders. 

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

Institutional investors, non-institutional investors and individuals can subscribe to non-convertible debentures. 

Category I (Institutional Category)

Institutional investors include the following.

1.    Banks, including commercial, cooperative and regional rural banks
2.    Public financial institutions and Statutory Corporations such as LIC, GIC, and UTI 
3.    Insurance companies
4.    Mutual funds
5.    Pension funds
6.    Foreign portfolio investors
7.    National Investment Funds
8.    Venture Capital or Alternate Investment Funds

Category II (Non-Institutional Category)

Institutional investors include the following.

1.    Corporates, including Cooperative Societies and body corporates, registered under applicable laws in India
2.    Trusts
3.    High Net Worth Individuals (HNIs)
4.    Public, charitable and private trusts, if authorised to invest in NCDs
5.    Partnership firms and limited liability partnership firms in the name of the partners
6.    Scientific or research organisations, if authorised to invest in NCDs. 

Category III (Individual Category)

Individual investors include the following.

1.    Resident Indians
2.    Hindu Undivided Families (HUFs) through the Karta
3.    Non-Resident Indians (NRIs) 

Individuals below 18 years of age are not eligible to invest in NCDs. Additionally, non-resident Indians (NRIs), foreign nationals, and persons of foreign origin cannot invest unless the issuer has obtained specific regulatory approvals. Further, individuals not deemed fit and proper by the regulatory authorities are also not eligible to invest in non-convertible debentures. 

It is essential to check the eligibility criteria set by the issuer and regulatory authorities before making investments. Foreign institutional investors, foreign portfolio investors, qualified portfolio investors, and overseas corporate bodies cannot apply for NCDs. 
 

Can the application be made on joint names?

Investors can apply for non-convertible debentures (NCDs) in joint names. It is a common practice, allowing a maximum of three single and joint investors to share the investment and its returns. When making a joint application, investors should ensure that all applicants are eligible to invest and meet the issuer's eligibility criteria. All joint applicants must also provide their Permanent Account Number (PAN) and other relevant Know Your Customer (KYC) details to the issuer.

Investors should note that the allocation will be in the applicant’s name mentioned in the form. The issuer will also give a single certificate for these debentures, bearing the names of all applicants. In case of transfer or transmission, the investors must follow the process specified by the issuer and regulatory authorities.

Investing in NCDs in joint names can provide the benefits of diversification and shared risk. However, one must also ensure they understand the terms and conditions and risks associated with the issue before making an investment decision.
 

How to purchase Non-Convertible Debentures (NCDs)?

Non-Convertible Debentures (NCDs) can be purchased from the issuer during the NCD issue period through a broker or the stock exchange where they are listed. Investors must complete the application process and provide the necessary KYC and other details to invest in NCDs. After listing, you can purchase NCDs from the secondary markets, similar to the stock market. 

Non-Convertible Debentures (NCDs) can be purchased from the issuer during the NCD issue period through a broker or the stock exchange where they are listed. Investors must complete the application process and provide the necessary KYC and other details to

Investing in Non-Convertible Debentures (NCDs) can provide investors with an opportunity to earn a regular fixed income. But it is essential to consider these factors before investing. 

1.    Credit Rating: NCDs with higher credit ratings have lower default risk, so investors should invest in NCDs with AAA or AA+ credit ratings. However, higher credit ratings may also translate to lower yields.

2.    Interest Rate: Higher interest rates can provide better returns, but investors should also consider the issuer's financial position and creditworthiness. One should also compare the interest rates different issuers offer and choose the best option.

3.    Tenure: The tenure of the NCD’s issue can affect the investment's liquidity and risk profile. Investors should choose a tenure that aligns with their investment goals and risk profile. Longer tenures may provide higher yields but carry higher risks.

4.    Redemption Terms: The NCD issue's redemption terms can affect the investment's liquidity and exit strategy. Investors should consider the redemption period, price, and call/put options before investing. Early redemption may also carry penalties.

5.    Issuer's Financial Position: Investors should conduct due diligence on the issuer's financial position, business operations, and management quality to assess the issuer's ability to honour the NCD obligations. Investors should also consider the industry and competitive environment in which the issuer operates.
 

Difference between Corporate FDs and NCDs

Corporate Fixed Deposits (FDs) and Non-Convertible Debentures (NCDs) are popular investment options for investors seeking fixed returns. These instruments offer a fixed interest rate and tenor but differ in several aspects, including the issuer, liquidity, credit risk, and interest rates.

a.    Issuer: Companies offer corporate FDs as deposits, whereas companies issue NCDs as debt securities. Investors invest their money in a company's FD account, while NCDs are bought and sold on the stock exchange.

b.    Liquidity: Corporate FDs are less liquid compared to NCDs. They usually have a lock-in period, and investors may have to pay the penalty for premature withdrawal. On the other hand, investors can trade NCDs on listed stock exchanges, providing investors with liquidity and the opportunity to exit early.

c.    Credit Risk: The credit risk associated with Corporate FDs and NCDs is different. The company's assets back corporate FDs, and investors have the priority of repayment in case of default. NCDs are unsecured, and the investor may face losses in case of default. However, they are rated by credit rating agencies, providing investors with an assessment of the issuer's creditworthiness.

d.    Interest Rates: The interest rates offered by Corporate FDs are generally lower than those offered by NCDs. Corporate FDs are safer than NCDs, and the issuer can afford to offer a lower interest rate. NCDs offer higher interest rates, reflecting the higher risk involved in the investment.
 

Key Benefits of Non-Convertible Debentures

1.    Fixed Returns: NCDs offer fixed returns to investors, which means the exact amount of interest they will receive throughout the tenure of the investment is known. It is a suitable investment option if you are seeking predictable returns.

2.    Diversification: NCDs offer diversification benefits to investors, as they can invest in NCDs issued by different companies and spread their investments across various industries, which can help mitigate risk.

3.    Higher Returns: NCDs typically offer higher returns than traditional fixed-income investments such as bank fixed deposits.

4.    Tax Benefits: Interest income earned from NCDs is taxed at a lower rate of 10%, making them a tax-efficient investment option for investors.

5.    Liquidity: NCDs are listed on stock exchanges, making them a liquid investment option. Investors can buy and sell NCDs, providing them with an exit route in an emergency.

6.    Credit Rating: NCDs are rated by credit rating agencies, providing investors with an assessment of the issuer's creditworthiness to make informed investment decisions and manage credit risk.

7.    Tenure: NCDs are available in different tenures, allowing investors to choose an option that aligns with their investment goals and risk profile.
 

Tips for Investing in Non-Convertible Debentures

a.    Evaluate the issuer’s creditworthiness before investing.
b.    Compare the interest rates offered by different NCDs and choose the one that offers the best rate.
c.    Look for NCDs with a good credit rating from a reputable agency.
d.    Choose NCDs with a shorter tenure to mitigate credit risk.
e.    Understand the liquidity and exit options before investing.
f.    Consider the tax implications of investing in NCDs.
g.    Seek professional advice before making a decision.
 

Conclusion

In conclusion, there are several Non-Convertible Debentures advantages and disadvantages to investors, including fixed returns, diversification, higher returns, tax benefits, liquidity, credit rating, and tenure flexibility. NCDs can be a suitable investment option for investors seeking predictable returns and are willing to assume credit risk.

However, investors should conduct thorough research before investing in NCDs. They should prior evaluate the issuer's creditworthiness, compare interest rates and credit ratings, and understand the liquidity and exit options. Investors should also consider the tax implications of investing in NCDs and seek professional advice before making an investment decision.
 

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Frequently Asked Questions

Risks associated with investing in Non-Convertible Debentures (NCDs) include credit risk, interest rate risk, liquidity risk, and reinvestment risk. 

If the yield on a Non-Convertible Debenture (NCD) reduces, the value of the NCD may increase. It is because the yield and the price of a bond or debenture have an inverse relationship. When the yield decreases, the price of the NCD may increase.

Non-Convertible Debentures (NCDs) are generally bought and sold on stock exchanges or in the over-the-counter (OTC) market.

It is possible to transfer ownership to another individual. NCDs are transferable securities, and the process involves executing a transfer deed and submitting it to the issuer or the registrar of the NCD. 

Generally, investors cannot withdraw NCDs before maturity, but some issuers may allow premature withdrawal under certain conditions.

The maximum tenure varies depending on the issuer and can be from a few months to several years.

Companies issue NCDs, while governments and corporations issue bonds.

NCDs are fixed-income securities similar to fixed deposits.

The minimum investment depends on the issuer and can range from thousands to lakhs of rupees.

NCDs are assigned credit ratings by credit rating agencies based on their creditworthiness and risk of default.

Yield is the return on investment from an NCD, typically expressed as a percentage of the initial investment.