Non-Convertible Debentures (NCD): Definition, Characteristics, and More

Non-convertible debentures (NCDs) are fixed-income instruments typically issued by companies with high credit ratings in the form of a public offering to accumulate long-term capital appreciation. They offer interest rates that are relatively higher than convertible debentures. Non-convertible debentures are classified as debt. They are not convertible into securities or equity. NCDs have a fixed maturity date, and the interest and principal can be paid monthly, quarterly, or annually, dependent on the specified fixed tenure. Compared to convertible debentures, they offer investors superior returns, liquidity, minimal risk, and tax advantages. You can invest in NCDs when the company announces them or after they trade on the secondary market. It would be best to examine the company's credit rating, the issuer's credibility, and the NCD's coupon rate. Procuring NCDs with a higher rating, such as AAA+ or AA+, would be advantageous. Characteristics of NCD Taxation - Tax Depending on the investor's tax bracket, NCDs bear tax implications. If NCDs are sold within a year, the income tax bracket will determine the STCG tax rate. If the NCDs are sold after one year or before the maturity date, a 20% LTCG with indexation will apply. The interest income from NCDs is taxed similarly to that from fixed-income securities under "other income." Let's calculate the NCD's after-tax return: - Credit score Credit rating agencies such as CRISIL, CARE, etc. rank businesses. A company's evaluation plays a significant role in determining its potential. A higher credit rating indicates that a company can fulfil its credit obligations. However, a low credit rating indicates the company faces significant credit hazards. Rating agencies will assign a lower ranking if an issuer fails to make payments. - Interest NCDs may offer a high-interest rate between 8 and 12 per cent if held until maturity. Interest is paid monthly, quarterly, semiannually, or annually. NCDs also provide a cumulative payout alternative. In addition, unsecured NCDs may offer a higher rate of interest. Considerations an investor should make - NCDs are susceptible to hazards associated with business and funding management. Consequently, the credit rating may suffer if the turnover is negatively affected. To counteract the impact, the company must borrow additional funds from banks or NBFCs. Before choosing a company NCD, it is advisable to consider several factors. - Credit Assessment of the Issuer: Choose a company with a grade of AA or higher. Credit rating computes the company's ability to generate cash from internal and external operations and its sustainability. This is the most reliable indicator of the company's financial health. - Quantity of Debt: For NCD investors, a background check on the company's asset quality can go a long way. If the company allocates more than fifty per cent of its total assets to unsecured loans, you should refrain from investing. - Capital Adequacy Ratio (CAR): CAR evaluates the company's capital to determine if it has sufficient funds to withstand potential losses. Ensure that the company you intend to invest in has a CAR of at least 15% and has maintained this level historically. - Allowances for Nonperforming Assets: The company must set aside at least fifty per cent of its assets for nonperforming assets, as this indicates the character of its assets. Consider it a red flag if the quality declines due to poor debts. - Rate of Interest Coverage The Interest Coverage Ratio (ICR) measures a company's ability to pay its loan interest at any time adequately. This ensures that the organisation can manage any potential tax evasions. - Your tax division NCDs are profitable for investors between the 10% and 20% tax brackets. This is because you can earn more if your tax bracket is minimal. Difference between FDs and NCDs for Corporations Corporate fixed deposits are extremely risky, whereas bank fixed deposits are insured up to Rs. 1 lakh. NCDs may be secured or unsecured depending on the principal amount and interest rate issued by the company offering debentures. A modest penalty is imposed on early withdrawals of FDIC-insured deposits. However, early withdrawals are not permitted on all varieties of FDs. NCDs cannot be redeemed before maturity. Since NCDs are publicly traded, they may be sold on the secondary market. If gains exceed Rs 10,000 on bank fixed deposits, tax is deducted. NCDs are subject to taxation; capital gains must be paid on interest income. NCDs held in Demat format are, however, exempt from TDS. The Deposit Insurance and Credit Guarantee Corporation insures bank fixed deposits of up to one lakh rupees. NCDs are not insured, but the company's assets collateralize them. Even though you cannot sell an FD on the market, FDs are more liquid than NCDs. You may trade your NCD, but you may not prematurely revoke it. The two types of non-convertible debentures are as follows: Guaranteed NCDs - Secured NCDs are safer because the company's assets support their issuance. If the company fails to make timely payments, investors can recover their money by selling its assets. However, interest rates on NCDs are modest. Unguaranteed NCDs - Unsecured NCDs are significantly risky than secured ones because the company's assets do not back them. Therefore, when the company defaults on its payments, investors are compelled to wait until they are paid, as the company has no assets from which to recover its debts. However, the interest rate offered on unsecured NCDs is higher than that on secured NCDs. Advice on investing in NCDs - Organisations will only use NCDs to raise funds for a specific business purpose. Only invest if the terms and conditions clarify how and where your money will be used. - Diversification, or investing in numerous companies and periods, can significantly reduce risk. - NCDs issued by a specific sector (NBFCS specialising in personal loans) are risky investments. This can result in increased risk exposure. - NCDs from secondary markets have historically generated greater returns. Purchasing older NCDs when a company issues a new one. - Never rely solely on the interest rate. Low NCD yields (which determine your real returns) will be irrelevant. - When its interest is due is the optimal moment to sell your NCD. It is the peak period for trading non-convertible debentures. You can anticipate earning more money from it. Conclusion Non-convertible debentures (NCDs) are fixed-income instruments issued by high-credit companies for long-term capital appreciation. They offer higher interest rates than convertible debentures and are tax-advantaged based on credit score, interest rate, and maturity. Investors should consider factors like credit risk, liquidity, and risk. Choose a company with a credit rating of AA or higher, assess asset quality, and consider Capital Adequacy Ratio (CAR) and Nonperforming Assets allowances. Invest in NCDs between 10% and 20% tax brackets, as they are more liquid than FDs. Non-convertible debentures (NCDs) are secured or unguaranteed, with modest interest rates and higher risk. Diversification, secondary market investments, and timing are crucial for successful investment.