Non-Convertible Debentures (NCDs)

~Sura Anjana Srimayi

Introduction

In the diverse universe of financial instruments, Non-Convertible Debentures (NCDs) stand out as a prominent fixed-income option. These are ideal for investors seeking regular returns and capital preservation without equity market exposure. As the name implies, NCDs cannot be converted into equity shares, distinguishing them from convertible debentures. Issued by companies to raise long-term funds, NCDs function as loans where the issuer agrees to pay periodic interest and return the principal on maturity.

NCDs attract investors with their blend of predictable income, relatively higher yields compared to traditional deposits, and lower volatility, making them an essential component for those aiming to diversify their debt portfolios.

What Are Non-Convertible Debentures?

A debenture is a debt instrument not backed by physical assets but by the issuer’s creditworthiness. Non-Convertible Debentures are a type of debenture with no option of conversion into equity. When an investor purchases an NCD, they are essentially lending money to the issuer. In return, the issuer commits to:

Fixed Interest Payments: A predetermined interest (coupon rate) is paid at regular intervals—monthly, quarterly, half-yearly, or annually.
Principal Repayment: The full face value of the NCD is repaid at maturity.

NCDs can be issued by public or private companies and financial institutions to meet various funding needs—like expansion, debt repayment, or working capital—without affecting shareholding.

Key Features of NCDs

Fixed Income: Guaranteed interest payments make NCDs appealing for income-focused investors.
Non-Convertible: Investors do not participate in equity upside or downside, shielding them from stock market volatility.
Fixed Tenure: Typically ranges from a few months to up to 10 years.
Credit Rating: Issued by SEBI-registered rating agencies (e.g., CRISIL, ICRA, CARE), helping assess the creditworthiness of the issuer.
Secured vs. Unsecured:
- Secured NCDs are backed by company assets.
- Unsecured NCDs rely solely on the issuer’s credit standing and usually offer higher returns.
Listed and Tradable: Many NCDs are listed on exchanges (NSE/BSE), offering liquidity, though trading volumes may vary.
Tax Implications: Interest income is taxable under "Income from Other Sources". Capital gains tax applies if sold before maturity.
Face Value: Generally issued at ?1,000 or ?10,000 per debenture.
Call/Put Options: Some NCDs may have options allowing early redemption by the issuer (call) or early exit by the investor (put).

Why Invest in NCDs?

Stable Income: Fixed interest ensures a consistent income stream.
Higher Returns: Generally offer better returns than bank fixed deposits or government securities.
Portfolio Diversification: Adds stability, reducing overall portfolio volatility.
Capital Safety: The principal is repaid at maturity, ideal for conservative investors.
Seniority in Liquidation: Secured NCDs offer higher recovery in case the company defaults.
Exit Option: Listed NCDs provide the flexibility to sell before maturity.

Risks to Consider

Credit Risk: The company might default on payments. Always check credit ratings, though they aren’t foolproof.
Interest Rate Risk: Rising interest rates can make existing NCDs less attractive in the secondary market.
Liquidity Risk: Low trading volumes may make it hard to exit early at a fair price.
Reinvestment Risk: Upon maturity, the reinvestment options may offer lower interest rates.
Call Risk: Callable NCDs might be redeemed early by the issuer, especially in falling interest rate scenarios, depriving investors of future higher interest payments.

Regulatory Framework & Due Diligence

Mandatory Credit Rating: Every public issue of NCDs must be rated by SEBI-registered agencies.
Information Memorandum (IM)/Prospectus: Contains all crucial details—company profile, financials, risks, issue terms—and is a key due diligence tool.
Debenture Trustee: Appointed to monitor issuer compliance and protect investor interests.
Companies Act Compliance: Issuers must adhere to the Companies Act, 2013 provisions related to debenture issues.

Investor Due Diligence Must Include:

Evaluating Credit Ratings: Understand what the rating implies about credit risk.
Reading the IM Thoroughly: Analyze financials, risks, and terms of issue.
Assessing Financial Health: Review balance sheets and profit & loss statements.
Understanding Terms: Look into interest rates, tenure, payment frequency, and any embedded options.
Considering Liquidity Needs: Check if the NCD is listed and actively traded.

Conclusion

Non-Convertible Debentures offer a compelling investment option for those prioritizing predictable returns, capital protection, and higher yields compared to conventional savings instruments. They serve as an important funding mechanism for companies and a stabilizing investment for individuals, particularly in turbulent market conditions.

However, like all investments, NCDs carry certain risks—particularly credit and interest rate risks—making thorough analysis and due diligence essential. Backed by regulatory oversight from SEBI and compulsory credit ratings, NCDs remain a solid choice for the informed investor looking to strengthen the fixed-income component of their portfolio.

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Disclaimer: Every effort has been made to avoid errors or omissions in this material in spite of this, errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in the next edition In no event the author shall be liable for any direct indirect, special or incidental damage resulting from or arising out of or in connection with the use of this information Many sources have been considered including Newspapers, Journals, Bare Acts, Case Materials , Charted Secretary, Research Papers etc.