Non-Convertible Debentures (NCDs)

The NCD full form is Non-Convertible Debentures, which are fixed-income instruments issued by reputed companies to raise long-term capital. These debentures offer higher interest rates compared to convertible ones. Eligible investors in India include individuals, banks, primary dealers, and corporate or unincorporated bodies.

Non-convertible debentures (NCDs) are fixed-income instruments with a specific tenure and fixed interest rates. Large companies issue them to raise capital without providing the option to convert them into equity. Investors seeking stable returns often prefer NCDs, as they offer predictable earnings. NCDs have a fixed maturity date and the interest can be paid along with the principal amount either monthly, quarterly, or annually depending on the fixed tenure specified. They offer relatively higher interest rates when compared to convertible debentures.

NCDs are backed by the creditworthiness of the issuer and are not backed by any collateral. Interest pay-outs are either monthly, quarterly, half-yearly, or annually. NCDs do offer a cumulative payout option as well.

Investors should consider the credit rating of the issuer before investing in NCDs. Companies are ranked by credit rating agencies such as CRISIL, CARE, etc. A higher credit rating means that the company has the ability to fulfil credit obligations. However, a low credit rating means that the company has high credit risks involved. If any issuing company fails to make payments, then the rating agencies give them a lesser ranking.

There are two types of non-convertible debentures: 

1. Secured NCDs:

Secured non-convertible debentures are a type of debt instrument where the issuer provides specific assets as collateral to secure the investment made by the debenture holders. In the event of a default by the issuer, the debenture holders have a claim on the specified assets pledged as collateral. This added layer of security makes secured NCDs less risky compared to unsecured counterparts.

Key features:

• Collateralised security: Secured NCDs are backed by tangible assets, such as properties, plants and machinery, or any other specified assets, which provide a safety net for investors.
• Lower risk: The presence of collateral reduces the risk for investors, as they have a claim on the underlying assets in case of default.

Investor considerations:

• Investors often find secured NCDs attractive due to the lower risk associated with the presence of collateral.
• Interest rates on secured NCDs may be slightly lower than those on unsecured NCDs, reflecting the reduced risk for investors.

2. Unsecured NCDs:

Unsecured non-convertible debentures do not have any specific assets pledged as collateral. Investors in unsecured NCDs rely solely on the creditworthiness and repayment capacity of the issuing corporation.

Key features:

• No collateral: Unsecured NCDs lack the backing of specific assets, making them riskier compared to secured NCDs.
• Higher risk-reward profile: Due to the absence of collateral, unsecured NCDs generally offer higher interest rates to compensate investors for the increased risk.

Investor considerations:

• Investors seeking potentially higher returns may be attracted to unsecured NCDs, but they should be aware of the higher risk involved.
• Credit rating assessments become crucial for investors in unsecured NCDs, as they rely heavily on the financial health and creditworthiness of the issuing corporation.

The choice between secured and unsecured NCDs depends on an investor's risk tolerance, return expectations, and the level of security they seek in their investment portfolio. It is essential for investors to conduct thorough due diligence, including assessing the credit rating of the issuing corporation, before making investment decisions in the Indian securities market.

Below are the key features of NCDs:

1. Credit rating

   Credit rating agencies such as CRISIL, CARE, etc., rank companies based on their creditworthiness. A higher credit rating means that the company has the ability to fulfil credit obligations. However, a low credit rating means that the company has high credit risks involved. If any issuing company fails to make payments, then the rating agencies give them a lesser ranking.

2. Interest

   NCDs have a fixed maturity date and the interest can be paid along with the principal amount either monthly, quarterly, or annually depending on the fixed tenure specified. They offer relatively higher interest rates when compared to convertible debentures. Interest payouts are either monthly, quarterly, half-yearly, or annually. NCDs do offer a cumulative payout option as well. Moreover, unsecured NCDs can offer a higher interest rate.

3. Issuance

   NCDs are made available to investors through open-market public issues conducted by companies within defined periods. Interested investors can purchase these debentures during the specified timeframe, contributing to the company's capital-raising efforts.

4. Tradable securities

   Non-Convertible Debentures are actively traded in the stock market. This tradability provides investors with the flexibility to buy or sell NCDs in the secondary market, enhancing market liquidity and allowing investors to manage their portfolios dynamically.

5. Credit rating

   Given that NCDs lack collateral backing, only companies with robust credit ratings can issue them. These credit ratings, regularly assessed by credit rating agencies, serve as a crucial determinant of an issuer's ability to fulfill credit obligations. This underscores the importance of creditworthiness in the issuance and investment in non-convertible debentures.

NCDs cater to a diverse investor base segmented into three categories:

1. Category I (Institutional Investors):

Includes entities such as:

• Banks (commercial, cooperative, and regional rural)
• Public financial institutions (e.g., LIC, GIC, UTI)
• Mutual funds and insurance companies
• Pension funds and venture capital funds
• Foreign portfolio investors and national investment funds

2. Category II (Non-Institutional Investors):

Comprising:

• Corporates, trusts, and charitable organisations
• High Net Worth Individuals (HNIs)
• Research organisations and partnership firms, provided they are authorised to invest

3. Category III (Individual Investors):

Includes:

• Resident Indians
• Hindu Undivided Families (HUFs)
• Non-Resident Indians (NRIs), subject to regulatory approvals

Investors must ensure they meet issuer and regulatory eligibility requirements. Certain individuals, such as minors and specific foreign entities, may not be eligible to invest.

When a company decides to raise capital through Non-Convertible Debentures (NCDs), it begins by issuing them to the public for a fixed period. This public issue is announced in advance and comes with detailed terms, including tenure, interest rate, and redemption date. During this window, eligible investors can subscribe to the NCDs directly through authorised platforms or agents. Once the subscription period ends, the allotment process is carried out based on demand and availability.

Following the closure of the public issue, the NCDs are listed on recognised stock exchanges as per the issuing company’s plan. Listing enhances liquidity by allowing investors to buy or sell NCDs on the secondary market. Interested investors who missed the initial issue can still invest in NCDs by purchasing them through registered stockbrokers or online trading platforms. This secondary market access adds flexibility and provides investors with the opportunity to enter or exit their investments more freely.

NCDs are largely influenced by the financial stability and creditworthiness of the issuing company. Since these instruments are not convertible into equity, they rely entirely on the issuer’s ability to honour debt obligations. As a result, investors should carefully evaluate the following aspects before committing funds:

1. Credit rating of the issuer

The credit rating offers insight into a company’s capacity to meet its financial commitments. It is advisable to invest in NCDs issued by companies with a strong credit rating—typically AA or higher—as this reflects a lower risk of default.

2. Debt level

Reviewing the issuer’s financial health is vital. This includes examining their debt-equity ratio and overall asset quality. A high level of debt compared to equity could indicate increased financial risk.

3. Capital Adequacy Ratio (CAR)

This ratio assesses whether a company has sufficient capital to absorb potential losses. A healthy CAR signifies that the business is better positioned to withstand economic fluctuations and financial stress.

4. Provisions for Non-Performing Assets

It is important to ensure that the company is consistently setting aside provisions for non-performing assets. This is usually a reflection of sound profit generation and financial management practices.

5. Interest coverage ratio

This metric indicates how easily a company can meet its interest obligations using its earnings. A higher interest coverage ratio suggests greater financial stability and a stronger ability to repay debt.

Read more: Know more about National Stock Exchange

1. Fixed returns:

   NCDs offer predictable returns, making them suitable for investors seeking stability.

2. Diversification:

   By investing in NCDs issued by different companies and industries, investors can reduce risk through diversification.

3. Higher returns:

   NCDs generally provide higher returns compared to traditional fixed-income instruments like bank fixed deposits.

4. Tax benefits:

   Interest earned on NCDs is taxed at a lower rate of 10%, making them a tax-efficient investment choice.

5. Liquidity:

   The tradability of NCDs on stock exchanges ensures liquidity, allowing investors to exit their investments if needed.

6. Credit rating insight:

   Credit ratings help investors assess the creditworthiness of issuers and manage risks effectively.

7. Tenure flexibility:

   NCDs are available in various tenures, enabling investors to align investments with their financial goals.

Let us understand the key differences between fixed deposits and non-convertible debentures:

Non-convertible debentures (NCDs) offer investors a fixed-income avenue with varying risk profiles. Whether you opt for secured or unsecured NCDs, it is crucial to conduct thorough research and understand the features and risks associated with each type. Diversification, careful assessment of credit ratings, and staying informed about market conditions are key elements for making informed investment decisions. As with any investment, it is advisable to consult with financial advisers to tailor your NCD investments to your financial goals and risk tolerance. By incorporating these tips into your investment strategy, you can make well-informed decisions and potentially enhance the overall stability and returns of your investment portfolio.