Introduction to NCDs

NCD stands for Non-Convertible Debenture. It's a type of long-term fixed-income security that companies use to raise capital from investors.

The term "non-convertible" indicates that these debentures cannot be converted into equity shares or other securities.

Understanding NCDs

Non-Convertible Debentures (NCDs) are essentially long-term debt instruments issued by companies offering a fixed interest rate. Typically, they come with a maturity period ranging from 2 to 10 years. You, the investor, can expect interest payments at intervals that suit your preference, be it monthly, quarterly, semi-annually, annually, or even at maturity. The specifics, like maturity and interest rates, can vary from one issuer to another.

Different Types of NCDs

NCDs generally fall into two categories: secured and unsecured.

Secured NCDs

Secured NCDs come with the backing of collateral. This means that your investment is somewhat safeguarded because, in the event of a default, the company is obligated to liquidate its assets to repay you. Due to this added security, secured NCDs tend to offer lower interest rates compared to their unsecured counterparts.

Unsecured NCDs

Unsecured NCDs, on the other hand, do not offer this security. These are riskier because they lack asset backing. However, they typically come with the potential for higher returns, hinging on the issuer's creditworthiness. Most companies prefer issuing secured redeemable NCDs, and you can find details about the type of NCD in the company's offering documents. Remember, you can’t withdraw your investment prematurely, though you may sell it on the secondary market.

Key Features of NCDs

Here are some salient features of NCDs:

• NCDs are issued for a span ranging from 2 to 10 years. If you wish to exit early, you can sell them on the stock exchange, provided they are listed.
• Companies often issue NCDs secured by a charge on their assets, making these investments relatively safer. If the company gets liquidated, you can stake a claim against the sale of these assets.
• Similar to Fixed Deposits (FDs), NCDs promise a fixed interest rate, which is usually more lucrative than FD rates.
• Investors have various interest payout options, including monthly, quarterly, semi-annually, annually, or at maturity.
• Listed NCDs can be traded like stocks on exchanges.
• Interest earned is taxable under your income tax slab, while trading gains are subject to short-term or long-term capital gains tax, depending on the holding period.
• The interest directly credits to the bank account you provide during application, following your chosen payout schedule.

Advantages of Investing in NCDs

Here are some benefits of NCDs:

• NCDs typically offer higher interest rates than fixed deposits, postal schemes, or other traditional securities.
• They serve as a long-term investment that can yield good returns if held until maturity, paying you the principal and interest at the end.
• Though premature withdrawal isn't an option, listed NCDs can be traded on stock exchanges like equities.
• They provide a steady income stream if you choose monthly or quarterly payouts.
• According to Section 193 of the Income Tax Act, interest on NCDs isn’t subject to TDS, although it is taxable under your tax slab.
• Being a long-term investment tool, you can't withdraw before maturity, but selling in the secondary market is possible.

Risks Associated with NCDs

Be aware of these risk factors:

• NCDs offer a fixed interest rate, which doesn’t account for inflation. Therefore, post-inflation returns might not be as appealing.
• Compared to debt mutual funds, post-tax returns from NCDs could be lower due to tax implications.
• If you sell an NCD in the secondary market before a year, you incur short-term capital gains tax. After a year, long-term capital gains tax is 20%. This is higher compared to the flat 15% on debt mutual fund gains.
• The minimum investment in NCDs is usually around Rs 10,000, which is higher compared to shares, mutual funds, or fixed deposits.

Checklist for NCD Investments

Consider these points before investing in NCDs:

• Each NCD issue is rated by certified credit rating agencies registered with SEBI. These ratings offer an unbiased analysis of the company’s financial health and risk profile.
• Compare the interest rates offered by the company with other investment options and consider your investment timeline.
• Verify the type of NCD being offered. Secured redeemable debentures are generally safer than unsecured ones.
• Ensure that your financial goals align with the long-term nature of NCDs, and assess your ability to hold the investment until maturity.
• While you can exit by selling NCDs on exchanges, liquidity is not as high as stocks, so the timing of your exit might be prolonged.
• The Capital Adequacy Ratio (CAR) of a company is a good indicator of its ability to withstand financial stress, making higher CAR a safer bet.

How NCDs Are Issued

Companies can issue NCDs through a public offering, inviting the general public to invest, known as an NCD IPO, or through a private placement to select investors.

Both issuance and listing are governed by the Companies Act and SEBI NCS Regulations.