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Non-convertible debentures ( NCD ) are fixed-income instruments, usually issued by high-rated companies. They offer relatively higher interest rates when compared to convertible debentures.

This article covers the following:

1. What are Non Convertible Debentures (NCDs)?

As an investor, you are always on the lookout for improved and more sustainable schemes. Even traditional and trusted investments lose their sheen due to market volatility. In such cases, Non-Convertible Debenture or NCD has proven to be a dark horse by delivering smaller but steady returns over time.

In the same line as traditional corporate FDs, NCD is also a fixed-income investment with a specific term and interest income. They are generally issued by companies to raise funds, and evidently, you cannot convert it to equities. To make up for this limitation, investors can enjoy supreme returns, liquidity, low risk and tax benefits when compared to convertible debentures.

2. Features of NCDs

a. 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.

b. Credit rating

Only companies with good credit rating are authorised to issue NCDs. Credit rating agencies rate the NCDs itself. However, the ratings are subject to revisions regularly.

c. Interest

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. Most NCDs also comes with a dual-earning potential – growth-based and interest-based or cumulative opportunities.

d. Return rates

When compared to corporate FDs, bank FDs, and government bonds which offer moderate returns (max 8%), NCDs generate higher returns up to 11%.

3. Things an investor should consider

NCDs are vulnerable to risks related to handling business and funding. Hence, the credit rating can take a hit if the turnover is negatively impacted. The company will have to borrow additional funds from banks or NBFCs to counterbalance the impact. Hence, it is advised to keep a few things in mind before opting for a company or NCD.

a. Credit Rating of the issuer

Choose a company with an AA rating or above. Credit rating calculates the firm’s potential to raise cash from its internal and external operations and its sustainability. This is the best parameter that can reveal the financial position of the company.

b. Level of Debts

Some background check on the asset quality of the company can go a long way for NCD investors. Do not invest if the company allocates more than 50% of its total assets towards unsecured loans.

c. Capital Adequacy Ratio (CAR)

CAR gauges the company’s capital and sees if the company has sufficient funds to survive potential losses. Ensure that the firm you plan to invest in has at least 15% CAR and have historically maintained the same.

d. Provisions for Non Performing Assets

The company must keep aside at least 50% of their assets towards NPAs as this is a positive indicator of their asset quality. If the quality drops due to bad debts, take it as a red flag.

e. Interest Coverage Ratio

The Interest Coverage Ratio or ICR determines the firm ability to comfortably settle the interest on its loans at any given time. This ensures that the company can handle possible evasions.

f. Your tax slab

Investors in the 10% and 20% tax slabs find NCDs lucrative. This is because you can earn more if your tax bracket is low.

4. Difference between Corporate FDs and NCDs

Before you start investing, knowing the difference between corporate fixed deposits and NCDs is crucial. Here are a few key differences between the two:

Corporate Fixed Deposits

NCDs

Unsecured against the assets of the bank or corporate

NCDs is either secured or not secured against the company assets

Exit route (especially early withdrawal) is difficult as it is often at the discretion of the company

Trade/transactions on stock exchanges are allowed

Interest earned (if more than Rs. 10,000) on corporate deposits has TDS

No TDS for registered NCDs

Deposit Insurance and Credit Guarantee Corporation insures bank FDs (up to Rs. 1 lakh).

NCDs are not insured but are secured against the company assets

While you cannot sell FD in the market, FDs enjoy more liquidity than NCDs

You can trade your NCD, but not withdraw it prematurely

No interest risk

The interest varies as per market

5. Types of NCDs

NCDs are of 2 kinds – secured and unsecured. Choose a secured NCD as it comes with a host of benefits aside from being protected against the company assets. Even if the company closes, you will get your dues.

6. Tips for investing in NCDs

a. Organizations resort to raising funds using NCDs only to meet a specific business purpose. Read the terms and conditions – if they do not offer you clarity on how/where your money is going to be used, do not invest.

b. Since NCDs are non-liquid in nature, start small or utilises that you may find unnecessary until the plan matures.

c. Diversification, i.e., investing across various firms and periods can reduce the risks considerably.

d. NCDs from one single sector (NBFCS that focuses on personal loans) are not safe to invest in. This can lead to higher risk exposure.

e. NCDs from the secondary markets have always delivered higher returns in the past. This is when you buy older NCDs when a firm issues a new one.

f. Never go by the interest rate alone. It will not matter if the NCD yield (that decides your real returns) remains low.

g. 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.

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