Investing in NCDs

A non-convertible debenture is a fixed income instrument where the issuer agrees to pay a fixed rate of interest to the investor. An NCD cannot be converted into equity of the issuing company unlike convertible debentures.NCDs are good substitutes for fixed deposits,especially company deposits.

Debentures are of two types secured and unsecured. The debentures with a “charge” on the assets of the issuer are called secured debentures. So in case of a default by the issuer, the secured debenture holders are paid by selling the assets against which the charge was created. Secured NCDs offer lower interest than their unsecured counterparts.

NCDs also offer various options such as cumulative and regular interest payouts.

NCDs are rated by credit rating agencies this is not always so in the case of company deposits.Moreover , NCDs ,especially the secured ones  are a far better option than company fixed deposits, given the charge on the assets of issuer.Also NCDs are listed on the stock exchanges.So exiting them is often easier and less painful than in the case of company deposits.

In the past couple of years NCDs from Tata Capital, Shriram Transport Finance and Larsen & Toubro Finance have been listed on the National Stock Exchange. Some of these instruments are fairly liquid, offering a smooth entry and exit to the retail investors.However while listing on the stock exchanges aims at providing liquidity, it does not guarantee it. It is better to look at the trading history of an individual instrument to check for its liquidity. Also an instrument that enjoys good liquidity till date may not remain liquid in future. But NCDs score over company fixed deposits where investors are absolutely at the mercy of the deposit-accepting company for premature withdrawal of  money.

Interest on NCD is taxed like the interest on a company FD.If the NCD is listed on a recognised stock exchange and held for at least 12 months before selling, the capital appreciation enjoyed by an investor is taxed as long-term capital gain.Long-term capital gains are taxed at 10.3% without indexation. Short-term capital gains are taxed at a marginal rate. If the NCD is listed on a stock exchange, there is no deduction of tax at source. Interest payable on company fixed deposits is subject to tax deducted at source.

NCDs typically come with a minimum tenure of five years and a maximum term of 10 years.If the rate of interest at the long end of yield curve is expected to go down in the near future, NCDs can be used to lock in the high interest rates  and enjoy possible capital appreciation since the prices of NCDs fluctuate with prevailing interest rates. But there’s a caveat here, if the rates were to go up in future, the price of the instrument may also fall. Of course the interest rate risk can be avoided by holding on to the NCDs till maturity.NCDs may also have a  a put or call option. A call option allows the issuer to buy the NCD back at the stipulated date by returning the face value of the bond. A put option allows the investor to surrender the bond in return of the face value at the stipulated date.If the rate of interest were to fall drastically, the issuers are most likely to call back the NCD exercising call options.

So if you are looking at an NCD as an investment for a couple of years, keep a track of interest rates and financial health of the issuer