All you want to know about investing in NCD

This article will explain you

• How NCDs works
• What should be the criteria to judge the right NCD?

What Is NCD? 

Debentures are long-term financial instruments which acknowledge a debt obligation towards the issuer. Some debentures have a feature of convertibility into shares after a certain point of time at the discretion of the owner. The debentures which have no option of to be converted into shares or equities are called non-convertible debentures (or NCDs).

Non – Convertible debentures are popular because of following reasons.

• NCDs are fixed income products

 NCDs are offered at predetermined rate of interest. Company assures a fixed interest on the investment with different options for interest payout methods like monthly, quarterly, half yearly or annually. Most of NCDs offer annual payout or cumulative payout. Investors should opt for cumulative payout to earn higher returns because in this method of payout interest is reinvested and paid at maturity.

• NCDs offer comparatively higher returns.

Fixed return to investors in two digits is a tempting offer. Usually fixed income instruments are unable to deliver returns in two digits. NCDs offer high return to investors in comparison to other fixed income instruments like bank deposits.

 Analysis of definition shows that

• Non-convertible debentures are one of the tools to raise long-term funds by companies through a public issue. In India, NCDs have to be issued of a minimum maturity of 90 days.
• To compensate the drawback of non-convertibility, the company offers usually higher rate of return compared to convertible debentures to lenders.

Non-convertible debentures also offer some other benefits

• High liquidity through stock market listing

NCDs get listed on stock exchanges therefore investors can sell it before maturity in stock markets. If interest rates are higher than offered by NCD then the price of NCD will be decrease and investor will have low return or loss if sold through secondary markets. If there is fall in interest rates after buying NCD then investor will get higher price and will have profit.

• Taxability

The interest earned on NCD is like normal income earned by the tax payer and is taxed at individual marginal income tax rate. If NCDs are sold after one year and before maturity is taxable as long term capital gains. Long term capital gain is exempted from tax or taxed at low rate.

• Safety

NCDs can only be issued by companies having a good credit rating as specified in the norms laid down by RBI for the issue of NCDs.

A higher ratings means the issuer has the ability to service its debt on time and carries lower default risk. A lower rating signifies a higher credit risk. A rating of AAA by CRISIL is suggested as highest safety of investment.

Types of NCDs

• Secured

A secured NCD is backed by the assets of the company. In case of default in future payment, the investor holding the debenture can claim it through liquidation of these assets.

• Unsecured

There is no backing in unsecured NCDs. If company defaults, the investor has no right on company’s assets.

Risk Involved Investing IN NCDs

• Credit risk.

If the company default on the future payment for unsecured NCD, an investor does not have any recourse. Most companies get rating through Agencies like CRISIL or CARE  give rating to most of companies based on various parameters which investors can check for credibility. In most cases instrument with AAA rating has never defaulted while it has grown with lower rating bonds.

• Liquidity risk.

NCD get listed on stock markets but low volumes can deprive investors of any opportunity in exiting prematurely.

Investor should pre-check following factors before investing in any NCD.

• Company’s financial health
• End use of funds.
• Any diversion from core business
• Rating of company

The investor must note that companies with low ratings offer very high returns to tempt investors. Investor must calculate post tax returns from NCDs because for 1% more returns than FDs, risk may not be worth taking to invest in NCDs.

List of upcoming NCD