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Non-convertible debentures (NCD) are fixed-income instruments, usually issued by high-rated companies in the form of a public issue to accumulate long-term capital appreciation. They offer relatively higher interest rates when compared to convertible debentures.
Non-convertible debentures fall under the debt category. They cannot be converted into equity or stocks. 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 benefit investors with their supreme returns, liquidity, low risk and tax benefits when compared to that of convertible debentures.
Example of NCDs: You can invest when the company announces NCDs or purchase after it trades on the secondary market. You must check the company’s credit rating, issuer credibility and the coupon rate of the NCD. It would help if you purchase NCDs of a higher rating such as AAA+ or AA+.
NCDs carry tax implications depending on the tax bracket the investor falls under. If NCDs are sold within a year, STCG will be applicable as per the income tax slab rate. If the NCDs are sold after a year or before the maturity date, LTCG will be applicable at 20% with indexation. The interest income from NCDs is taxed in a similar manner as fixed income securities under ‘income from other sources. Let’s calculate the post-tax return from the NCD:
|Interest from NCD||Post-tax return @10.4%||Post-tax return @20.8%||Post-tax return @ 31.2%|
Companies are ranked by credit rating agencies such as CRISIL, CARE etc. To determine the potential of a company, its rating plays a major role. 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.
NCDs may offer a high-interest rate ranging from 7% to 9% if held till maturity. 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.
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 NCD.
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.
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.
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.
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.
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.
Investors in the 10% and 20% tax slabs find NCDs lucrative. This is because you can earn more if your tax bracket is low.
Corporate Fixed Deposit
Corporate FDs are highly unsafe, whereas, bank FDs are insured up to Rs.1 lakh.
NCDs is either secured or unsecured depending on the principal amount and interest rate issued by the company offering debentures.
FDs can be withdrawn before maturity with a small penalty applicable on an early withdrawal. However, premature withdrawals do not apply to all types of FDs.
NCDs cannot be withdrawn before maturity. Since NCDs are listed on the stock market they can be sold in the secondary market.
Bank FDs attract TDS if gains are beyond Rs.10,000.
Tax implications do apply on NCDs, capital gains need to be paid on the interest earned. However, NCDs held in Demat form are exempted from TDS.
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
Following are the two kinds of non-convertible debentures:
Secured NCDs are considered safer of the two kinds as their issues are backed by the assets of the company. In the event of the company failing to pay on time, then the investors can recover their dues by liquidating the company’s assets. However, the interest offered on NCDs is low.
Unsecured NCDs are much riskier than the secured NCDs as the assets of the company do not back these. Hence, when the company defaults on its payment, the investors have no choice but to wait until they receive payments as there are no assets of the company to recover their dues. However, the interest rate offered on unsecured NCDs is higher than that of secured NCDs.