calsiNon Convertible Debentures (NCDs) are Fixed Income Products that offer higher returns other than any Fixed Income Product. e.g. Bank Fixed Deposit, Company Deposit, Postal Deposit etc. 

This post explains the following concepts about NCDs

 

  1. What is  Non Convertible Debentures (NCDs)
    • Type of NCD
  2. Benefit in  Investing NCD
  3. Regulation of investing in NCD
  4. Is it safe to invest in NCDs?
  5. Taxation
  6. Selection of NCD

 

  1. What is Non Convertible Debentures (NCD)

In Simple word, NCD is almost like a Fixed Deposit offer by a company.

 Whenever company wants to raise money from the public company issue debt paper for a specified period where is pays fixed interest on investment. This paper is a known as Debenture.

Non Convertible Debentures (NCD) means not convert these Debentures in shares & on maturity the principal amount along with accumulated interest is paid to the NCD Holder.

Type of NCD – There are two type of NCD Secured & unsecured

  1. Secured NCD – is backed by the assets of the company fails to make re-payment at maturity, the asset can be liquidated to pay the debenture holders.
  2. Unsecured NCD – is not backed by specified assets. If the Company defaults, they will be treated as a normal creditors.

 

  1. Benefit of Investing in NCD

If one is looking for an investment that generates fixed income periodically, NCDs may be an ideal investment as it offers.

  • Higher rate of interest as compared to fixed deposits, postal savings or similar investments.
  • If the bonds are listed, liquidity as one can sell it in the secondary market before its maturity
  • If listed bond possibility of capital appreciation i.e. one can sell your bond at a price higher than your cost price in the market

 

  1. Regulation of Non Convertible Debentures

SEBI regulation covers guidelines for issue and listing of  Non Convertible Debentures (NCDs) with maturity over one year. RBI draft guidelines cover provisions relating to issuance of Non-Convertible Debentures (NCDs) of maturity less than one year. An extract from the guidelines {Securities and Exchange Board of India (issue and listing of debt securities)(amendment) regulations, 2012 & Issuance of Non-Convertible Debentures (Reserve Bank) Directions, 2010} is given under.

 

  1. Is it safe to invest in NCDs?  

NCDs are mostly secured against assets of the issuing company, risk of default is low. In addition, debentures of blue-chip companies have less risk as these firms have robust finances. Small companies have more risk and so offer higher rate of interest

In terms of Section 71 (5) of the companies Act, it has been made mandatory for any company making a public/rights issue of debentures to appoint one or more debenture trustees before issuing the prospectus and to obtain their consent which shall be mentioned in the offer document.

The Debenture Trustees shall:

  • Protecting the interests of the debenture holders by addressing their grievances.
  • Ensuring that the assets of the company issuing debentures are sufficient to discharge the principal amount.
  • To ensure that the offer document does not contain any clause which is inconsistent with the terms of the debentures or the Trust Deed
  • To ensure that the company does not commit any breach of the provisions of the Trust Deed.
  • To take reasonable steps as may be necessary to undertake remedy in the event of breach of any covenant in the Trust Deed.
  • To convene a meeting of the debenture holders as and when required.

In the case of bankruptcy – secured debt holders will be paid first by selling off the secured assets. Whatever is left is used to pay off unsecured debt holders, and then whatever is left (which is usually nothing) is given to the shareholders. That’s why it’s said that secured debt is relatively safer than unsecured debt for bond holders.

 

  1. Taxation 

For Tax Purpose NCDs are treated as Debt Investment (similar to Fixed Deposit). 

The interest earned is added to your income as “income from other sources” and taxed accordingly.

TDS on NCD There is no TDS (Tax Deducted at source) deduction for NCD held in D’mat form, while in case of NCD held in Physical form, TDS would be deducted if the annual interest payout is more than Rs. 5000.

Short Term Capital Gain If you sell NCDs on stock exchange before one year from the date of purchase, Short Term Capital Gains Tax is applicable. Tax rates depend on the tax slab you fall into.

Long Term Capital Gain If you sell NCDs on stock exchange after one year from the date of purchase, Short Term Capital Gains Tax @20% with indexation & 10% without indexation is applicable. 

  1. Selection of NCDs

Rating – Various rating agencies such as CARE, CRISIL, ICRA rates NCDs. The higher the rating, the lower the risk. For example, NCD with high AAA rating is better than that with a AA.

Interest Rate – Currently the average rates being offered are in the range of 8.50% to 11% depends on the company rating. Lower rating higher rate basis.

Credibility of the Issuer/Promoter – You must do a research & back ground study of the company which is issuing the bond. Check if the company has any history of default on its payment. However if the company has a good consistence history of repayment to its creditors then it is better to invest in NCDs of that company.

Company Financial –

Capital Adequacy Ratio (CAR) – This ratio is used to measure the capital of a company. This is calculate as a percentage of the firm’s risk weighted assets.  A CAR of more than 15% is necessary. It is also important that you check whether the company has maintained this ratio over the years.

Bad Debts – Always check the company’s asset quality before investing.

Interest Coverage Ratio – This ratio is used to ascertain whether the company is in good position to pay off the interest on its debt. If the ratio is 2.5 or more, it indicates that the company is in a reasonable position to deal with any possible default in the issue.  

Liquidity – Most of all NCDs listed on Stock Exchanges and available in D’mat form. This makes NCDs liquid, as the volumes are low and it may be difficult to find a buyer. The best option to hold the investment until maturity.