Unravelling NCD's (Non Convertible Debentures)

We as an investor are always tempted by higher returns, specially in a time when interest rates offered on bank FD have move down in the range of 8.5 -9 % without knowing risk associated with it.

Another such wave of offering higher returns on your investment is about to come in the form of NCD's or Non Convertible Debenture. But as we are going to invest our hard earned money we need to know nitty gritty of the instrument.

Let's understand what NCD's are:

Whenever a corporate wants to raise money from public they issue a debt paper which is for a specified period and pays a fixed interest this debt paper are known as debentures . Debentures can be convertible as well as Non convertible.

Convertible Debentures : The Debentures which pays interest at fixed rate and on maturity date are converted to Shares of the company are convertible debentures.

Non Convertible Debentures : The Debentures which pays interest at fixed rate and on maturity returns the  capital amount are NCD.

Even NCD's can be of 2 types :

• Secured Debentures : As an security it is backed by asset of the company and if it fails to pay, the investor holding the debentures can claim it through liquidation of the assets.
• Unsecured Debentures : Contrary to above it is not backed by any security in case company defaults the amount would be paid only if any amount left after paying off for the secured creditors.

Features of NCD

NCD's normally works more or less like company deposits. One advantage of NCD is they are listed on stock exchange and theoretically speaking they provide liquidity.However, there is no active market for NCDs on the wholesale debt market segment of the stock exchanges and their liquidity is low. You might not be able to find a buyer for your NCDs if their trade volumes on bourses are insignificant.

Any Indian company can raise money through NCDs if it has a tangible net worth of at least Rs 4 crore and has been sanctioned loans by banks or financial institutions which is classified as 'standard asset' and not as bad debt.

Companies seeking to raise money through NCDs have to get their issue rated by agencies such as CRISIL, ICRA, CARE and Fitch Ratings. NCDs with higher ratings are safer as this means the issuer has the ability to service its debt on time and carries lower default risk.But the rating provided is at the time of issuance and may change during the tenure.

Interest rates on NCD

Normally NCD provides a higher interest rate then the market or Bank FD and comes with long tenure. Best suited for individuals who have  lower risk profile to build their retirement corpus and also for retirees during low interest rate scenario. NCD's come with lot of interest payment options viz; monthly, quarterly, annually and Cumulative. 

Interest rates also depends on rating of the issue. Lower rating means higher interest rate and vice versa.

Taxation

Interest on NCD do not attract TDS, but interest is taxable and is added to income for that year.

Capital Gain :

NCD's are listed on stock exchange and if sold on exchange it is taxed like debt fund. If sold before 1 year,  profit will be added to income and taxed at per tax slab. But any profit made selling after 1 year and before maturity would be taxed as long term capital gain. The applicable tax rate is 10.30% without indexation.

Risk involved 

NCD has some inherent risk. Investor need to check companies financial and end uses of the funds. Checking for rating can help a bit. 

Many a times we have seen that although the issue is secured but is backed by assets which may fluctuate in valuation. Like if we take case of Gold finance company mainly engaged in finance against Gold, comes with  secured NCD's backed by asset (Gold) as guarantee. 

As we know that gold has also become an speculative asset and if there is any major fall in prices of Gold. The company might not be able to recover its loan, due to which loan default rate might increase. It may result in default of NCD payment. Investors would not be able to recover their NCD value inspite of being secured as even after liquidation of asset i.e gold the amount recovered would be much less.

Please consult your financial advisor before investing in any such instrument.