Non Convertible Debentures ( NCD )
Non Convertible Debentures(NCDs) are a financial instrument that is used by companies to raise long-term capital. This is done through a public issue.
Non Convertible Debentures ( NCD )are a debt instrument with a fixed tenure and people who invest in these receive regular interest at a certain rate.
Non Convertible Debentures ( NCD ) 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.
Some debentures can be converted into shares after a certain point in time. This is done at the discretion of the owner. However, this is not possible in the case of NCDs. That’s why they are known as non-convertible.
Types of Non Convertible Debentures ( NCD):
(1)SECURED Non Convertible Debentures ( NCD)
(2)UNSECURED Non Convertible Debentures ( NCD)
A SECURED Non Convertible Debentures ( NCD) one that is backed by the company’s assets.In case company fails to pay ,investors can claim the payment through liquidation of assets.
A UNSECURED Non Convertible Debentures ( NCD) is one that is not backed by the company’s assets.As a result they are riskier than secured Non Convertible Debentures(NCD)
Features of Non Convertible Debentures ( NCD):
Non Convertible Debentures ( NCD) carry tax implications depending on the tax bracket the investor falls under. If NCDs are sold within a year or lesser STCG will be applicable as per the income tax slab rate. If the NCDs are sold after a year or more or before the maturity date, LTCG will be applicable at 20% with indexation.
Companies are ranked by credit rating agencies such as CRISIL, CARE etc. To determine the potential of a company, it’s rating plays a major role. Higher credit rating means that the company has the ability to fulfil credit obligations. However, 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 lesser ranking.
NCDs offer high interests. The interest usually ranges from 8% to 12%. Interest payouts are either monthly, quarterly, half-yearly or annually. NCDs do offer cumulative payout option, as well.
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.
Benefits of NCDs:
A. BETTER RETURNS:
Secured NCDs provide a higher NCD interest rate to their investors.
B. GOOD LIQUIDITY:
Sell NCD investments on stock exchanges or exercise the Put/Call option.
C. NO UPFRONT TAX:
No tax is deducted at source as per the provisions of Sec 193 of the IT Act.
NCD Investments add diversification to your portfolio with income security.
Things to consider before investing in NCDs:
A. Organisations 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. Diversification, i.e., investing across various firms and periods can reduce the risks considerably.
C. NCDs from one single sector (NBFCS that focuses on personal loans) are not safe to invest in. This can lead to higher risk exposure.
D. 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.
E. Never go by the interest rate alone. It will not matter if the NCD yield (that decides your real returns) remains low.
F 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.
The NCD(Non-Convertible Debenture) issue process is similar to the IPO process. Investors apply for NCD shares through a broker. Based on the subscription, they receive the number of NCD shares. The NCD’s are credited to the demat account and the money gets deducted from the trading/bank account.
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