What are Non-Convertible Debentures (NCDs)?

A Non-Convertible Debenture (NCD) is a fixed-income debt instrument issued by a corporation that cannot be converted into equity shares. In simpler terms, when you invest in an NCD, you are lending money to the issuer (a company) for a fixed period at a predetermined interest rate (coupon). At maturity you get back your principal along with accrued interest. Unlike convertible debentures which give you the option to convert into the company’s shares, NCDs remain purely debt.

Corporations issue NCDs to raise long-term funds (for capital expenditure, expansion, refinancing) without diluting equity. For investors, NCDs offer higher interest relative to many bank products, but come with company credit risk.

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Types of NCDs

NCDs can be classified under several schemes. The most fundamental is:

1. Secured NCDs

These are backed by specific assets (collateral) of the issuing company, for example, land, plant & machinery, receivables. If the issuer defaults, holders of secured NCDs have a claim on those assets. Because of that collateral layer, secured NCDs carry relatively lower risk and correspondingly somewhat lower coupon rates.

2. Unsecured NCDs

Here no specific assets are pledged. The investor relies purely on the issuer’s creditworthiness and debt-servicing capacity. Because of the higher risk, unsecured NCDs offer higher coupon rates. But in case of default, the recovery is less predictable.

Other variations & features include:

• Listed vs unlisted NCDs: Some NCDs are listed on exchanges and can be traded (liquidity), others are privately placed.
• Short-term vs long-term tenure: Tenure may range from a few years to even a decade or more, depending on issuer and structure.
• Cumulative payout vs periodic interest: Some NCDs pay interest monthly/quarterly/annually; others accumulate interest and pay at maturity.

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Key Features of NCDs

Here are the major characteristics:

• Fixed tenure/maturity date: The NCD specifies a date when the issue matures and principal is repaid.
• Fixed or floating interest (coupon): Most Indian NCDs offer fixed coupon rates; some may have floating or step‐up structure.
• Non-convertibility: The “non-convertible” label means you cannot convert the debenture into company’s equity shares. That differentiates them from convertible debentures.
• Credit rating: Issuers of NCDs are typically rated by agencies such as CRISIL, ICRA, CARE. The rating gives insight into issuer risk. Higher rated = lower risk (and usually lower coupon).
• Tradability: If the NCD is listed on a recognised exchange, you may buy/sell in the secondary market, which adds liquidity.
• Seniority: In the capital structure, debenture holders rank above equity but below secured creditors. In case of liquidation, asset‐backed issues will give secured holders first claim.
• Tax treatment: Interest income from NCDs is taxable as per your income tax slab. Capital gains if sold before maturity are subject to STCG/LTCG rules as applicable.\

Returns on Non-Convertible Debentures (NCDs)

Non-convertible Debentures are known for offering fixed and predictable returns, often higher than fixed deposits or savings instruments. The returns primarily depend on the issuer's creditworthiness, tenure and prevailing interest rates in the market.

1. Interest Rate Range:

• Secured NCDs: Generally offer between 8-10.5% p.a., as they are backed by company assets and carry lower risk.
• Unsecured NCDs: Typically provide 10-12.5% p.a., to compensate for the higher risk associated with no collateral.

2. Interest Payment Options:

Investors can choose how they receive returns, based on their cashflow needs:

• Monthly, Quarterly, or Annual Payouts: Ideal for those seeking regular income.
• Cumulative Option: Interest is reinvested and paid at maturity, offering a higher effective yield.

3. Market-Linked Fluctuations:

While returns are fixed at the time of investment, the market value of NCDs can fluctuate if sold before maturity. When interest rates rise, the price of existing NCDs tends to fall, and vice-versa.

4. Tax on Returns:

Interest earned on NCDs is fully taxable as per the investor's income tax slab under " Income from Other Sources". If sold before maturity on the exchange, capital gains tax applies.

• Short-term: Taxed at the investor's slab rate (if held <12 months).
• Long-term: 10% without indexation (of held> 12 months).

Example:

For instance, if you invest ₹5 lakh in a 10% NCD for 5 years, you could earn ₹50,000 annually in interest, totalling ₹2.5 lakh in 5 years, excluding tax implications.

Who Can Invest in NCDs?

n Indian context, eligible investors include:

• Individual investors/residents (provided they fulfil KYC, demat requirements).
• Non-Resident Indians (NRIs)/Persons of Indian Origin (PIOs) subject to RBI/FEMA guidelines (check specific issue terms).
• Institutional investors: banks, insurance companies, mutual funds, pension funds etc. Many corporate NCD issues have separate categories for non-institutions and retail.

You will typically need a Demat account (for listed issues) and should subscribe via your broker/bank or apply during the public issue window.

How to Purchase / Invest in NCDs?

Step-by-step process:

1. Open a Demat account (if you don’t already have one) via your bank or a broker.
2. Monitor the market or IPO calendar for new NCD issues: the company will publish a prospectus/offer document giving coupon rate, tenure, secured/unsecured status, etc.
3. Submit your application in the public issue (if available) during the subscription window.
4. Alternatively, if the NCD is listed on the stock exchange, you can buy it on the secondary market through your broker.
5. Once allotted or purchased, your NCD will appear in your Demat account. You’ll receive interest as per the schedule and principal at maturity (assuming no default).
6. Monitor the issuer’s credit rating and financial performance over the tenure to assess risk continuity.

Factors to Consider Before Investing

Because NCDs carry credit risk and some market risk, consider the following:

• Credit rating of the issuer: Prefer issues with strong ratings rather than low/marginal ratings. A high rating reduces default risk.
• Debt levels & leverage: Check issuer’s debt-to-equity, interest coverage ratio (how many times interest is covered by earnings) and overall debt servicing capacity.
• Capital Adequacy / Asset quality: For NBFC/finance companies issuing NCDs, check CAR/NPA levels. Though not always relevant for non-finance-companies, analogous parameters apply.
• Liquidity / tradability: If the NCD is listed and has reasonable secondary market volume, you’ll have an exit option. If unlisted, you may be locked in till maturity.
• Tenure and interest rate environment: Longer tenure means more exposure to falling coupon yields or credit risk. If interest rates in the market rise, existing fixed-rate NCD value may drop.
• Issuer’s business model / purpose of funds: Why is the company raising via NCD? Expansion, refinancing, debt repayment? The purpose affects risk.
• Call/Put options: Some NCDs may have options for early redemption (call) or pre-payment (put) which affect your return scenario.

Benefits of NCDs

• Fixed returns: For investors seeking predictable income, NCDs provide a fixed coupon that helps in budgeting.
• Higher yields than many bank products: Because corporate credit risk is higher than bank deposits, they often offer better interest.
• Diversification: Adding NCDs to an investment portfolio can diversify away from equity risk, especially if you select high-quality issuers.
• Liquidity (if listed): Some NCDs are traded on exchanges so you can buy/sell before maturity if needed.
• Tenure flexibility: Many issues come with varied tenures (3/5/7/10 years) allowing alignment with your horizon.
• Transparency (credit ratings, structure): Because major issuers require ratings & disclosures, you get more information to judge risk.
• Credit-worthiness edge: If you pick high-rated secured NCDs, you get near-bond-level safety with higher yields.

Risks of Investing in NCDs

It’s important to be aware of risks:

• Credit/default risk: If issuer becomes distressed, it may default on interest or principal payments. High attention required on issuer’s financials.
• Liquidity risk: Not all NCDs trade actively; selling before maturity may mean accepting a lower price or no buyer.
• Interest rate risk: If market interest rates rise, the value of fixed coupon NCDs falls (just like bonds).
• Lack of early redemption: Many NCDs do not allow easy early exit unless you sell on market.
• Tax implications: Interest is fully taxable; losses on sale may affect return. Some investors mistakenly believe NCDs are tax-free (they are not).

Steps to Invest in NCDs

1. Open a Demat account with your bank or broker if you don’t already have one.
2. Screen for upcoming NCD public issues (offer document contains coupon, tenure, secured/unsecured, rating).
3. Apply during the issue period and pay with KYC completed.
4. After allotment, hold the NCD in your Demat account; interest payments will be credited to linked bank account.
5. If the NCD is listed, you may track the secondary market; decide whether to hold till maturity or sell early (subject to market).
6. Monitor issuer performance and credit rating; consider selling if you see credit deterioration.
7. At maturity, redeem principal, check that issuer honours repayment.

Frequently Asked Questions (FAQs)