Non-convertible debentures fall under the debt category. They cannot be converted into equity or stocks. NCDs have a fixed maturity date and the interest can be paid along with the principal amount either monthly, quarterly, or annually depending on the fixed tenure specified. They benefit investors with their supreme returns, liquidity, low risk and tax benefits when compared to that of convertible debentures.
Example of NCDs: You can invest when the company announces NCDs or purchase after it trades on the secondary market. You must check the company’s credit rating, issuer credibility and the coupon rate of the NCD. It would help if you purchase NCDs of a higher rating such as AAA+ or AA+.
Funding is essential for a company to not only invest and expand but also to run its day-to-day operations. When a firm needs to raise money, it may consider debt, stock, venture capital, and other methods. Banks, non-banking financial companies, debt funds, and companies are increasingly relying on private placements of listed and non-listed Non-Convertible Debentures (NCDs) for fundraising from players such as pension funds, insurance agencies, foreign portfolio investors, and mutual funds to pay down debt and on-lend.
What do you mean by Non-Convertible Debentures?
Debentures are long-term financial assets that acknowledge the issuer’s debt commitment. Some debentures include the option of being converted into shares at the owner’s choice after a set period of time. Non-convertible debentures are debentures that cannot be converted into shares or equity (or NCDs). A Non-Convertible Debenture (NCD) is a debt instrument issued by a corporation, including NBFCs, with an original or initial maturity of less than one year and issued through a private placement. These debentures are used by firms for rising long-term funding through a public offering. In order to compensate for the non-convertibility, lenders are typically offered a higher rate of return than with convertible debentures.
Features of NCDs
Taxation
NCDs carry tax implications depending on the tax bracket the investor falls under. If NCDs are sold within a year, STCG will be applicable as per the income tax slab rate. If the NCDs are sold after a year or before the maturity date, LTCG will be applicable at 20% with indexation. The interest income from NCDs is taxed in a similar manner as fixed income securities under ‘income from other sources. Let’s calculate the post-tax return from the NCD:
| Interest from NCD | Post-tax return @10.4% | Post-tax return @20.8% | Post-tax return @ 31.2% |
| 9% | 8.064 | 7.128 | 6.192 |
| 9.5% | 8.512 | 7.524 | 6.536 |
| 10% | 8.96 | 7.92 | 6.88 |
Credit rating:
Companies are ranked by credit rating agencies such as CRISIL, CARE etc. To determine the potential of a company, its rating plays a major role. A higher credit rating means that the company has the ability to fulfil credit obligations. However, a 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 a lesser ranking.
Interest:
NCDs may offer a high-interest rate ranging from 7% to 9% if held till maturity. Interest payouts are either monthly, quarterly, half-yearly or annually. NCDs do offer a cumulative payout option, as well. Moreover, unsecured NCDs can offer a higher interest rate.
Characteristics of Non- Convertible Debentures
- Limited credit risk: An NCD loses value as the system’s interest rate rises and gets value when the rate falls. When an NCD is held until maturity, however, the stated return is likely to be realised, and the risk of interest rate volatility is reduced or decreased.
- Higher rate of return: Historically, NCDs have delivered excellent interest rates as compared to other fixed-income investments.
- Flexible Term: Ranging from two to twenty years, this allows for greater maturity options.
- NCDs are rated by credit rating companies that are certified and professional.
- NCDs are normally listed securities, which mean they can be sold in the secondary market before expiration.
- No Taxation: According to section 193 of The Income Tax Act, there is no tax deduction at source (TDS) on NCDs provided in DEMAT method and listed on a stock market.
- Moreover, because NCDs are listed securities, they can profit from stock market changes and experience capital appreciation.
- Interest Payment Alternatives: NCDs offer a variety of interest payment options, including monthly, quarterly, half-yearly, and annual interest payments.
Eligibility for Investing in Non-Conventional Debentures (NCDs)
Institutions:
- NCDs can be purchased by Public Financial Institutions, Statutory Corporations, Commercial Banks, Cooperative Banks, and Regional Rural Banks.
- NCD-authorized Provident Funds, Pension Funds, Superannuation Funds, and Gratuity Funds.
- SEBI-registered Venture Capital and/or Alternative Investment Funds.
- IRDA-registered insurance companies
- National Investment Funds (NIFs).
Non- Institutional:
- Companies, bodies corporate, and organisations that are registered under Indian law and are permitted to invest in NCDs.
- NCDs can be invested in by public/private charitable/religious trusts.
- Groups that are authorised to invest in NCDs are scientific and/or industrial research organisations.
- In the name of the partners, partnership firms are formed.
- The LLP Act of 2008 allows for the formation and registration of limited liability partnerships (No.6 of 2009).
Individuals
- Individuals of Indian descent who live in the area.
- Hindu Undivided Families
What is the Procedure for Issuing NCDs in NBFCs?
- According to conventional market practise, the company’s financial position must be communicated to potential investors.
- The investors must obtain a certified copy of the investors stating that the company has met all of the RBI’s qualifying conditions.
The corporation must follow all of the laws of the Companies Act of 2013, as well as any RBI restrictions:
- The debenture certificate must be granted within the time frame established by the Companies Act of 2013.
- The company determines whether NCDs are issued at face value with a coupon rate or as zero-coupon instruments with a discount rate to face value.
Major Provisions under Companies Act, 2013 on NCDs
The provisions relating to the issuing of NCDs are covered under Section 71 of the Companies Act, 2013 (“Act”) and Rule 18 of the Companies (Share Capital & Debenture) Rules, 2014. Specific provisions to keep in mind when issuing Debentures are as follows:
- The company’s Board of Directors has the authority to issue NCDs under section 179(3) of the Act.
- Debentures with voting rights cannot be issued.
- A secured debenture issue may be made as long as the redemption date is not more than 10 years from the date of issue. Before dealing with the matter, please note that the compliance and limits (i.e., Board Resolution or Special Resolution as the case may be) outlined in Section 180 of the Companies Act 2013 must be met.
- Such a debenture issue shall be secured by the creation of a charge on the company’s properties or assets, with a value adequate for the timely repayment of the debentures’ principal and interest.
- The corporation cannot grant debentures to more than 500 people unless it first appoints a debenture trustee, whose principal responsibility would be to protect the interests of debenture holders and to resolve their problems.
- In accordance with the terms and circumstances of the debentures’ issue, a corporation must pay interest and redeem the debentures. As a result, it should be emphasised that a firm can issue debentures with a 0% interest rate.
- The tribunal may, on the application of any or all of the debenture-holders, or the debenture trustee, and after hearing the parties involved, direct the corporation to redeem the debentures instantly on payment of interest and principal due thereon, by ordering.
Difference between Corporate FDs and NCDs
| Corporate Fixed Deposit | NCDs |
Corporate FDs are highly unsafe, whereas, bank FDs are insured up to Rs.1 lakh. | NCDs is either secured or unsecured depending on the principal amount and interest rate issued by the company offering debentures. |
FDs can be withdrawn before maturity with a small penalty applicable on an early withdrawal. However, premature withdrawals do not apply to all types of FDs. | NCDs cannot be withdrawn before maturity. Since NCDs are listed on the stock market they can be sold in the secondary market. |
Bank FDs attract TDS if gains are beyond Rs.10,000. | Tax implications do apply on NCDs, capital gains need to be paid on the interest earned. However, NCDs held in Demat form are exempted from TDS. |
Deposit Insurance and Credit Guarantee Corporation insures bank FDs (up to Rs.1 lakh). | NCDs are not insured but are secured against the company assets |
While you cannot sell FD in the market, FDs enjoy more liquidity than NCDs | You can trade your NCD, but not withdraw it prematurely |
No interest risk | The interest varies as per market |
FAQs
What are privately placed non-convertible debentures (NCDs)?
Privately placed non-convertible debentures (NCDs) are fixed-income securities issued by companies, including unlisted NBFCs, to raise capital. Unlike convertible debentures, NCDs do not convert into equity shares and have a fixed tenure and interest rate.
Can unlisted NBFCs issue NCDs?
Yes, unlisted NBFCs can issue privately placed NCDs to raise funds. The issuance is subject to compliance with regulatory requirements set by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI).