What are Non Convertible Debentures (NCDs)?

When a company wants to raise money from the public it issues debentures. Some of these are convertible debentures and they can be converted to equity share at the time of maturity. Others are NCDs or Non-Convertible Debentures, which cannot be converted into equity shares at the time of maturity. These typically offer higher interest rates than bank deposits and are like company fixed deposits.

Type of NCDs: NCDs are of 2 kinds – Secured and Unsecured. Secured NCDs have control over the assets of the issuing company, whereas unsecured NCDs do not get any backing if the company defaults. Hence secured NCDs are preferred over unsecured NCDs at the time of a financial breakdown or liquidation. However, as the unsecured NCDs are riskier, they offer a higher rate of interest than the secured ones.

Features of NCDs

1.  Issuance: Companies provide NCDs through open issues, which potential investors can purchase within specific periods. Investors also have the option to buy NCDs from stock markets.

2.  Listing on Stock Exchange: NCDs are listed instruments and can also be sold before maturity, in secondary debt markets, without incurring the penal charges. The perfect time to sell your NCD is when its interest is due. It is the prime trading time for a non-convertible debenture. You can expect to make more money out of it.

3.  Credit rating: Only companies with good credit ratings are authorized to issue NCDs. Credit rating agencies rate the NCDs itself. However, the ratings are subject to revisions regularly. The credit rating of an NCD is inversely proportional to the interest it offers. The higher the credit rating, the lesser interest the NCD will offer.

4.  Interest Rates offered: When compared to corporate FDs, bank FDs, and government bonds which offer moderate returns (max 8%), NCDs generate higher returns up to 12%. Investors can also choose from various options for interest payout such as monthly, quarterly, half-yearly or annually, though most NCDs offer an annual and cumulative payout.

5.  Tax implications: There is no TDS on listed NCDs. Gains from NCDs are taxed differently from interest on bank deposits, depending on their term. When sold on stock exchanges, short-term capital gains of NCDs sold before one year is taxed as per the income slab of the individual. Any sale arising by selling NCDs after one year and before maturity is taxable as long-term capital gain.

6.    NCDs VS FDs: Currently, SBI offers 6.50 percent interest on its five-year fixed deposit whereas NCDs offered a return of 8-12 percent depending on the lock-in period. By allowing investors with the option to lock into better interest rates for longer periods, NCDs offer the advantage of overbank deposits. Most investors go in for FDs mostly because of the easier access and relatively ‘on-demand’ liquidity they provide. NCDs are listed on the BSE and NSE, though they also provide liquidity over a longer tenure.
      
      Also Read: Why a DEMAT account is a must for 21st Century Investor?

Factors to consider when investing in Non-Convertible Debentures (NCDs)

Never go by the interest rate alone. It will not matter when the issuer of NCDs are into unsound business practice.  Since NCDs are non-liquid in nature, start small or utilizes that you may find unnecessary until the plan matures. Investors need to consider below aspects carefully before investing in NCDs

Safety: The financial health of the issuer, the reputation and financial strength of the promoter group, the strategic importance of the issuer to the promoter group and the support provided by the promoter group in terms of capital infusion and management support, the credit rating and the quality of corporate governance are some critical factors that need to be looked into before selecting an NCD for investment. Both secured and unsecured NCDs are available for investment. The Investors must choose secured NCDs for investment for obvious reasons.

Credit Rating: A Credit Rating is a perfect way to assess the issuer’s credit performance. These ratings are an indicator of how well and how time can the company repays the obligation. The rating is generated by agencies such as CRISIL, FITCH, CARE, Brick Works, or ICRA.  Opt for AAA-rated NCDs. The interest rate on most of the AAA-rated NCDs is usually a little higher than bank fixed deposits, around 9%. However, the lower-rated NCDs can give you a higher interest rate. Don’t look at the interest rate on NCDs in isolation. The higher the return, the risk is also likely to be higher.

Liquidity: Liquidity plays a major role in investment decisions. Before investing one must check the liquidity situation of the issuer and its ability to repay debt in case of a stress event in markets. More importantly, the investor needs to check for liquidity in the NCDs / bonds of the issuer in the secondary markets. Lower rated issues from relatively small and less reputed corporate are generally illiquid. Hence, it makes sense to invest in reputed groups whose bonds / NCDs are traded frequently in secondary markets.

Diversification:  Investing all of your money in a single NCD can lead to huge losses if the issuer fails to repay on time. Investing across various firms and periods can reduce the risks considerably. For instance, one must not put a substantial chunk of investments in NCDs of housing finance companies as they are considered to be riskier in this environment. At a macro level, one must not invest more than 25% of their total debt portfolio in NCDs as a class. The remaining debt portfolio can be invested in debt mutual fund schemes, small savings schemes, etc., to diversify the risk.

Tenure: NCDs come with various tenures. The longer the tenure, the riskier it gets as one cannot say with certainty how the business will be in next 10 years. Economic and business cycles tend to change over such long periods. It is relatively easier to project the outlook for the next three or five years. Moreover, the yields of longer-term bonds are more sensitive to interest rate trends. Hence, one should ideally invest in three- or five- year NCDs only.

How to invest in NCDs?

1. Public Issue: During the public issue of the bonds, you can invest in them by submitting a physical form furnishing the details as requested. Also, you can make an investment online through your Demat Account.

2. Secondary Market: NCDs are listed on NSE or BSE or at times on both after the Public Issue. You can invest in these bonds through your trading account like the way you invest in shares. NCDs are exposed to liquidity risk. So even if NCD gets listed, low volumes can deprive investors of any opportunity in exiting prematurely. Hence Patience with adequate market knowledge is the key to success.  

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Look before you leap:

We have shortlisted below companies (investment through NCDs ) with Excellent Track Record in corporate governance and offers attractive interest rate.

1.    Shriram Transport Finance Company Ltd

2.    Shriram City Union Finance Ltd

3.    Mahindra and Mahindra Financial Services Ltd

4.    Tata Capital Financial Services Ltd

5.    L & T Finance Ltd

Also Read: Why a DEMAT account is a must for 21st Century Investor?