Fixed income instruments have always attracted investors because of regular income generation attached to them and especially when the equity markets are highly volatile. However, most of the fixed income instruments provide a lower income generation. In such a scenario, any fixed income vehicle offering 10%-12% returns is also very tempting. This is what Non-convertible debentures offer. In the recent past, the business enterprises are issuing this instrument for raising funds pretty often. Non-convertible-debentures are gaining popularity because even though they are fixed income vehicles, they offer higher returns in comparison to other fixed investment options.
What Are Non-convertible debentures?
Non-convertible debentures are commonly abbreviated as NCDs. It is a source of finance to the company issuing it and a fixed income instrument for the investors. The company uses it to gather long-term capital for the business, and the process of issuing this instrument is through a public offering. This is a debt instrument, and thus it comes with a specific tenure attached to it for which the investor will earn regular interest income, and on the maturity, the principal amount will be paid-off.
Non-convertible-debentures are those debentures that are unchangeable in nature. This means they cannot be converted into shares at any given point in time. However, since they cannot be exchanged for shares after a certain point in time, to compensate that benefit which its counterpart has, this one offers other sets of advantages, out of which higher return is one.
Types of Non-convertible debentures
The Non-convertible debentures can be classified into two categories which are Unsecured and Secured NCDs.
1. Unsecured Non-convertible Debentures:
These types of NCDs do not come with any collateral security backing from the company’s end, and in case the company fails to pay, the investors cannot recover the money. It is riskier than its counterpart.
2. Secured Non-Convertible Debentures:
Non-convertible debentures which are backed by collateral assets of the company are called secured Non-convertible-debentures. These debentures hold minimal risk for the investors because, in the event where the company fails to pay, the investor can recover their money by liquidating the assets used as a mortgage.
Characteristics Of Non-convertible debentures
Certain features of Non-convertible Debentures make it a lucrative investment option some of such significant features are stated below –
- Capital Gains:
- Superior returns in the form of Interest:
- Adequate Tenure:
- TDS is not applicable:
- Risk Factor:
- Easy to handle:
These debentures are listed on major exchanges of the nation such as NSE and the BSE. The investors can also sell these instruments in the secondary market. Any form of profit earned by selling these debentures in the secondary market is referred to as capital gain. The profit from selling these instruments depends on the prevailing market interest rate at the time of sale.
Since Non-convertible-debentures have a high rate of return associated with them, they have gained substantial popularity. In the last few years, the secured NCDs have earned around 9%-10% of return on an annual basis. There are also different types of interest pay-out options available such as monthly, semi-annually, quarterly and annually. However, the majority of the companies pay interest annually on a cumulative
The tenure of Non-convertible-debentures can range from 2 to 20 years. This is for long-term investment purpose and provides stable cash inflows throughout the entire tenure. However, since one cannot gauge or predict the financial feasibility of the company beyond 5-6 years, it is always better to invest for a maximum period of 5 years at a time.
On these debentures, there are no TDS charges applicable. Other taxes apply to Non-Convertible-Debentures. A short-term capital gain tax is charged if the instrument is sold before the completion of one year in the secondary market and when a profit is made from such a sale. The long-term capital gain tax would be applicable on the proceeds from the sale of these debentures when it is sold after the completion of one year of purchase and before maturity. With indexation, the rate would be 20% whereas, without indexation, the rate applicable is 10%.
Though the Non-convertible debentures are very lucrative because of the factors mentioned above, there is a great deal of risk which is associated with it. There is a high risk of default or credit risk. If the company does not fare well in the future and makes a payment default, then the cash flow can stop, and in case you have invested in unsecured debenture, your investment cannot be recovered. To mitigate the risk, you must always invest in NCDs of the companies that are rated at least an AA by a significant and reputed rating agency such as Crisil or Moody’s ratings.
You can invest in an NCD through a Demat Account. This makes it easy to maintain and monitor the investment.
Important aspects to be considered for Non-convertible debentures
While making investments in NCDs, you need to be well aware of the below-mentioned aspects.
- The magnitude of Debt:
- Issuer’s Credit Rating:
- Capital Adequacy Ratio:
- Interest coverage ratio of the issuer:
It is always important to know how much assets, the issuing company can deal out for the unsecured loans. If the ratio is above 50 %, try to avoid investing in the Non-convertible debentures of that company.
To be aware of the financial standing of the company issuing the Non-convertible debenture, you must have a clear idea of its credit rating.
The Company must have half of their assets allocated for NPAs. This indicates good quality of their asset. If the percentage drops then there the investors must be cautious about investing in such company’s NCDs.
This ratio helps in understanding and measuring the capital of the company and its financial capacity to survive significant The firm you are choosing to invest must have maintained at least 15% CAR throughout their years of operations.
This ratio indicates how well the company pays off its interest on every loan and debt within the stipulated time period.
Hence, Non-convertible debentures can provide a regular return higher than its contemporaries if you choose the issuing company wisely.