Non-Convertible Debentures (NCDs): A Comprehensive Guide

Non-Convertible Debentures (NCDs) are a popular fixed-income investment option in the financial markets. They provide individuals and institutional investors with an opportunity to earn stable returns over a specified tenure. Unlike convertible debentures, NCDs cannot be converted into company shares and must be redeemed at maturity.

This article delves into NCDs in detail, covering their features, types, benefits, and key considerations for investors.

What Are Non-Convertible Debentures?

An NCD is a type of debt instrument issued by corporations to raise funds. It is a fixed-income security that offers investors a predetermined interest rate over a specific tenure. The term "non-convertible" signifies that these debentures cannot be converted into equity shares of the issuing company. Instead, investors receive fixed interest income, typically paid quarterly, semi-annually, or annually, with the principal amount repaid at the end of the maturity period.

Types of Non-Convertible Debentures

1. Secured NCDs

Secured NCDs are backed by the issuer’s assets, which serve as collateral. This means that in the event of a default, investors have a legal claim over the pledged assets, which may include property, machinery, or other tangible assets owned by the company.

Because these NCDs carry lower risk, they generally offer lower interest rates compared to unsecured NCDs.

2. Unsecured NCDs

Unsecured NCDs, as the name suggests, are not backed by any collateral. These debentures are issued based solely on the issuer’s creditworthiness. In case of default, investors do not have a claim over any specific asset of the company, making them riskier than secured NCDs.

Due to the higher risk, unsecured NCDs typically offer higher interest rates as compensation. While they can provide better returns, investors must carefully assess the credit rating and financial stability of the issuing company before investing.

Features of Non-Convertible Debentures

Key features of NCDs include:

• Fixed Income: NCDs offer a fixed interest rate, which can be paid monthly, quarterly, semi-annually, or annually, depending on the debenture’s terms.
• No Conversion to Equity: NCDs cannot be converted into equity shares, unlike convertible debentures. Investors receive fixed interest payments and principal repayment, but they do not gain ownership in the issuing company.
• Priority Over Equity Shareholders: In the event of liquidation, debenture holders have priority over equity shareholders when it comes to receiving repayment of principal and interest.
• Rating: NCDs are rated by credit agencies such as CRISIL, ICRA, and CARE to indicate the issuer’s creditworthiness. A higher rating suggests lower risk, while a lower rating indicates higher risk.
• Taxation: Interest earned on NCDs is taxable as per the investor’s income tax slab. Some NCDs, particularly those issued by public sector undertakings (PSUs), may offer tax benefits under specific government schemes.

Who Can Invest in Non-Convertible Debentures?

NCDs are available for a wide range of investors, including:

• Individual Investors: Any individual who meets the issuer’s eligibility criteria can invest in NCDs.
• Institutional Investors: Entities such as mutual funds, insurance companies, and pension funds frequently invest in NCDs to diversify their portfolios and earn stable, fixed-income returns.
• Foreign Institutional Investors (FIIs): Depending on regulatory guidelines, FIIs may invest in NCDs issued by Indian companies.
• Trusts and Corporates: Trusts, charities, and corporate bodies often invest in NCDs as part of their fixed-income strategy.

How to Purchase Non-Convertible Debentures?

Investors can purchase NCDs in the primary market during a public issue through brokers, financial institutions, or authorised online platforms. Once listed on stock exchanges like NSE and BSE, they can also be bought or sold in the secondary market through a stockbroker, similar to shares.

Things to Consider Before Investing in Non-Convertible Debentures

Before investing in NCDs, it is important to consider the following factors:

• Interest Rate: Compare the interest rate offered with other fixed-income investments like government bonds, fixed deposits, and corporate bonds to ensure they adequately compensate for the associated risk.
• Liquidity: While listed NCDs can be traded on stock exchanges, liquidity also depends on market demand. Low liquidity may make it difficult to exit early at a favourable price.
• Issuer’s Financial Health: Analyse the financial health and stability of the issuing company. Review its balance sheets, profitability, and debt levels.
• Maturity Period: Choose an NCD tenure that aligns with your financial goals. Longer tenures typically offer higher interest rates but lock in funds for an extended period.

Benefits of Non-Convertible Debentures

NCD investors can benefit from:

• Fixed Returns: NCDs offer a predictable, fixed return, making them an attractive option for conservative investors seeking steady income.
• Diversification: Adding NCDs to an investment portfolio helps diversify risk, as they are less correlated with equity market movements, reducing overall volatility.
• Higher Returns Compared to FD: NCDs often offer higher returns compared to traditional fixed deposits, making them appealing to investors looking for better yields.
• Security (for Secured NCDs): Secured NCDs are backed by the issuer’s assets, providing investors with a claim in case of default, reducing credit risk.
• Priority Over Equity Shareholders: NCD holders have a higher claim on the company’s assets than equity shareholders, reducing the risk of loss in the event of financial troubles.

Corporate Fixed Deposits vs Non-Convertible Debentures

Both corporate fixed deposits (FDs) and NCDs are fixed-income instruments, but they have notable differences:

• Interest Rates: NCDs generally offer higher returns than corporate FDs due to their higher risk.
• Security: Corporate FDs are typically unsecured, while secured NCDs offer collateral as a safeguard.
• Liquidity: NCDs are tradable on the stock market, providing more liquidity than corporate FDs, which generally cannot be sold before maturity.

Conclusion

Non-Convertible Debentures (NCDs) can be an attractive investment for those seeking fixed returns and portfolio diversification. However, they come with inherent risks, such as issuer creditworthiness and liquidity constraints.

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