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NCD is the abbreviation for Non-Convertible Debenture. A debenture is a long-term fixed-income instrument issued by companies to raise funds from investors.
Since it is non-convertible security, it cannot be converted into shares or other forms of security.
NCD Meaning
Non-convertible debentures, popularly known as NCDs, are long-term debt securities issued by corporations at a specific interest rate. NCDs are issued with a long-term maturity of 2 to 10 years. Interest is paid at different intervals depending on the investor's preference: monthly, quarterly, semi-annually, annually, or at maturity. Each issuer may have different maturities, interest rates and intervals.
NCD Types
There are mainly two types of NCDs, secured and unsecured NCDs.
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Secured NCDs Meaning
Secured NCDs are debt securities that are backed by collateral. These types of debt securities provide a certain guarantee of repayment.
Investments in collateralized NCDs are safer and more reliable because these NCDs are backed by assets of the company. If the company defaults, the investor money can be recovered from liquidation of assets. The company is obligated to sell the assets that serve as collateral for the NCDs and pay out the investors.
The interest rates for secured NCDs are not as high as those for unsecured NCDs.
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Unsecured NCDs Meaning
Unsecured NCDs are unsecured debt instruments. As the name "unsecured" implies, these NCDs have comparatively higher risk as they are not backed or secured by assets/collateral.
The extent of risk and safety of unsecured NCD is based on the creditworthiness of the issuer as these are not backed by any assets or collateral.
Unsecured debt instruments offer a higher return than secured NCDs.
Generally, companies issue secured redeemable NCDs. You can know the NCD type issued by the company in the offering documents. The investors cannot withdraw from NCD before maturity. However, they have the option to exit by selling NCDs in the secondary market.
NCD Features
NCD has below characteristics:
- Long term Investment
NCD is issued for a longer tenure ranging from 2 to 10 years. Once invested you cannot withdraw from the NCD till maturity. To exit you can sell the NCD in the stock market provided the NCD is listed and you find a match for your trade.
- Flexible Tenor
NCD is a long-term investment security that comes with different tenor options. The investor can choose to invest for the desired tenure as per their investment goal.
- Low Risk
The corporates generally issue NCDs that are secured by a charge on the assets of the Company. Thus, there is low risk in such investments and are considered safe. In case of liquidation of the company, the investors can claim their money against the sale value of such assets.
- Interest offering security
Like Fixed Deposits (FD), NCD offers interest to the investors at a fixed rate for a fixed tenor. The rates offered on NCD are higher than the FD rates. The interest details are mentioned in the offering document of the NCD issuing company.
- Interest Payout Options
NCD offers investors with different interest payout options like monthly, quarterly, six-monthly, annually or at maturity. The investors can choose the option that best suits their needs.
- Tradable Instrument
Listed NCDs are part of secondary market/stock exchanges. Investors can trade in NCD similar to shares.
- Taxation
The interest from NCD is taxable as income from other sources and taxed as per the investor tax slab. Any gains as a part of NCD trading are subject to short-term (as per tax slab) and long terms based (10% without indexation and 20% with indexation) on the holding period.
- Direct Bank Credit
The interest on the NCD gets directly credited to the bank account given at the time of NCD application. The credit happens automatically as per the chosen option for interest payout.
NCD Benefits
NCD offers various advantages to investors as stated below:
- Higher Interest Rates
NCDs offer higher interest rates as compared to returns on fixed deposits, post office schemes or other traditional securities.
- Return on Investment
NCD is a long-term investment that gives investors a good return on the invested amount if kept until maturity. Investors receive interest and the principal amount at the maturity of the NCD.
- Exit Possible
Although NCDs cannot be withdrawn at any time by investors, listed NCDs can be traded on the stock exchange platform in an open market just like equity shares.
- Periodic Fixed Income
NCDs offer investors a regular fixed income when opting for monthly or quarterly payout options. The NCDs need to be held till maturity to receive this fixed income.
- No TDS on Interest earned
The interest earned through NCD is not subject to TDS as per Section 193 of the Income Tax Act. Though TDS is not applicable, interest on NCD is taxable as per the investor tax slab.
- Option to Exit
NCDs being a long-term investment tool, you cannot withdraw from it before maturity. However, listed NCDs provide an option to exit by selling them on the secondary market.
NCD Risk Factors
- Inflation not accounted
The biggest disadvantage of NCDs is that the returns do not take inflation into account. NCD offers a fixed rate of interest for the entire chosen tenor. The post-inflation returns from NCDs may not be as attractive as compared to other dynamic investment options available in the market.
- Taxable
Compared to other debt investment options like debt mutual funds, post-tax returns from NCD could be significantly lower. Investing in NCDs has tax implications because the interest in NCDs is as per the income tax slabs.
If investors trade the NCD in the secondary market before one year, a short-term capital gain tax gets levied. After the first year, a long-term capital gain tax is imposed at 20 per cent. Compared to this, the gains on debt mutual funds get taxed at a flat rate of 15%.
- Higher Minimum Investment Amount
The minimum investment amount in NCD is generally Rs 10,000. This is higher as compared to investment in shares, mutual funds, and FDs where you can start your investment with a minimum of Rs 500 as well.
NCD Investment Checkpoints
An investor should consider below factors before investing in NCDs:
- Credit Rating
Each NCD issue is rated by certified and SEBI-registered credit rating agencies (CRA). The CRA provide an unbiased and independent rating based on their analysis of the company’s financial and business risks, its ability to pay timely interest, company management, etc. The ratings provided by the CRA provide an indication of the safety of your invested funds.
- Interest Rates
An investor should check the interest rates offered by the issuing company and compare with other available options and the time horizon.
- Types of Non-Convertible Debentures
An investor should check the type of NCD offered by the company. Generally, a company offers secured redeemable debentures. However, it is important to verify the NCD type in the offer documents. The unsecured debentures are a little riskier than secured debentures.
- Investment Goal
It is important to understand one’s financial goal before any investments. NCD is a long-term investment security. Thus, one needs to assess the holding capacity to get the expected returns.
- Liquidity Risk
Investors can exit from the NCD by selling them on the exchange floor. However, the liquidity is not as high as in the case of equity shares. Thus, one needs to understand that one may need to wait to exit at the desired price.
- Capital Adequacy Ratio
The capital adequacy ratio (CAR) indicates the position of a company to withstand losses and risks. It reflects the solvency of the company. NCDs of the companies with higher CAR are generally better and safer.
NCD Issuance
NCDs can be issued by public or private limited companies either by way of the public offer by inviting the general public to subscribe to the issue known as NCD IPO or through private placement. In private placement, the offer is made to a selected group of investors.
The issuance and listing of NCD are regulated by the Companies Act and SEBI NCS Regulations.