A Beginner's Guide to Investing in Non-Convertible Debentures

Organizations need capital funding for their short-term and long-term business requirements. They procure financing either through loans or by issuing bonds and debentures to the public. The issuer of these bonds and debentures pays interest to the investors. In India, debenture investments are generally done through private companies that issue them. Debentures are also a kind of bond that is not attached to collateral. Put simply, debentures are unsecured bonds. Since debentures are riskier than bonds, the interest rate on debentures is generally higher than bonds. Treasury Bills, Treasury Bonds, and low-rated (less than AA+) Corporate Bonds are examples of debentures. NCDs (Non-Convertible Debentures) are a type of debenture that cannot be converted into shares or equity. An investment in NCDs should be based on your risk profile, risk appetite, and financial goals. Both NCDs and bonds are great ways to diversify your portfolio.

What is a Non-Convertible Debenture?

Some debentures can be converted into equity shares at the discretion of the owner. Debentures that can be converted into shares are called Convertible Debentures (CDs) and those that cannot be converted into shares are called non-Convertible Debentures (NCDs). The interest rates of NCDs are higher than CDs as they are comparatively riskier than CDs.

For investment purposes, NCDs could be a great inclusion in your portfolio. It not only adds diversification but NCD interest rates are typically higher than those of bonds and FDs. You can buy NCDs when they are initially issued by the issuing company or buy them later in the secondary market when it is trading. You can buy NCDs both online and offline.

Types of Non-Convertible Debentures

There are two types of NCDs:

• Secured NCDs: Secured NCDs are those NCD investments that are backed by the issuer/borrower company's assets. If the borrower defaults on investor payments, the investors can claim payment through the borrower’s assets.

• Unsecured NCDs: In India, NCD investments that are not backed by the issuer company's assets are called unsecured NCDs. The investors cannot claim payment as the NCDs are not secured by collateral and hence are riskier than CDs.

Things to Know Before Investing in NCDs

While making any kind of investment, you should look at the risk, returns, and liquidity of the instrument among other things. Apart from that, you should also look at your risk appetite, financial goals, and investment horizon. The same goes for NCD investments too. Before you decide on the best NCD to invest in, you should be aware of the following aspects:

NCDs

SecurityThey are unsecured and not backed by the assets of the issuer as security.

Interest RateThe NCD interest rates are higher than bonds

Interest TypeThey usually have a fixed interest rate.

Interest PaymentsThe interest is paid periodically based on the issuer’s performance.

MaturityNCDs cannot be withdrawn before maturity. Since NCDs are listed on the share market, they can be sold in the secondary market.

Risk FactorNCD schemes are high-risk, high-return investments.

ConversionsNCDs cannot be converted to stocks of the company.

TenureDebentures like NCDs are generally issued for short term capital requirement; hence have a shorter tenure than bonds.

Issuing BodyPrivate companies generally issue NCD Schemes

PriorityA debenture holder is the first one to be paid before equity shareholders.

Things to Know Before Investing in NCDs

Since NCDs are comparatively riskier than Convertible Debentures (CDs), NCDs have a higher interest rate than CDs.

When searching for an NCD to invest in, you should check the following:

• Credit Rating: Choose an NCD with an AA rating or above. The credit ratings are issued by agencies like CARE, FITCH, CRISIL, ICRA, etc.

• Level and Type of Debt: It is not advisable to invest in an NCD if the company allocates more than 50% of its total assets towards unsecured loans.

• Capital Adequacy Ratio (CAR): CAR is a measurement of the company’s assets to see if it can survive potential losses. A CAR of 15% or more is recommended.

• Provisions for Non-Performing Assets: The company must keep aside at least 50% of its assets towards NPAs; it is a positive indicator of their asset quality. If the percentage goes below this, it is an indicator of the bad debts of the company.

• Interest Coverage Ratio (ICR): It determines the company’s ability to repay loans from its creditors.

• Tax Slab: If you come under the low tax bracket of 10-20%, NCD investment earnings are more.

Conclusion

If you are looking for a high-return, high-liquidity, and tax-efficient investment, NCDs are an ideal option.